Annuity

Annuities

Everyone is living longer. It’s quite common these days for people who reach their retirement age, and live 20 years beyond it.

If you want to be sure that your income lasts as long as your life does you should manage the risk of “outliving your assets” by purchasing an annuity as part of your retirement strategy.

Annuities can enhance your income from Social Security, pension, 401(k) plan or IRA.

What is an annuity?

An annuity is an agreement for one person or organization to pay another a series of payments.

Usually the term “annuity” relates to a contract between you and a life insurance company but a charity or a trust can take the place of the insurance company.

Categories of annuities are classified by:

• Nature of the underlying investment – fixed or variable
• Primary purpose – accumulation or pay-out (deferred or immediate)
• Nature of pay-out commitment – fixed period, fixed amount, or lifetime
• Tax status – qualified or nonqualified
• Premium payment arrangement – single premium or flexible premium

An annuity can be classified in several of these categories at once. For example, you might buy a non-qualified single premium deferred variable annuity.

In general, annuities have the following attractive features:

Tax deferrment on investment earnings

Many investments are taxed year by year, but how about the investment earnings, capital gains and investment income?

Annuities aren’t taxable until you withdraw your money. This tax deferment is also true of 401(k)s and IRAs; however, unlike these products, there are no limits on the amount you can put into an annuity.

The minimum withdrawal requirements for annuities are much more liberal than they are for 401(k)s and IRAs.

Protection from creditors

If you own an immediate annuity (that is, you are receiving money from an insurance company), generally the most that creditors can access are the payments as they’re made.

Some state statutes and court decisions also protect some or all of the payments from those annuities.

Your money in tax-favored retirement plans, such as IRAs and 401(k)s, are generally protected, whether invested in an annuity or not.

Annuity investment options

There are a variety of investment options from annuity companies. You can invest in a fixed annuity which would credit a specified interest rate, similar to a bank Certificate of Deposit (CD).

If you buy a variable annuity, your money can be invested in stock or bond (or other) mutual funds. Recently, annuity companies have created various types of “floors” that limit the extent of investment decline from an increasing reference point.

For example, the annuity may offer a feature that guarantees your investment will never fall below its value on its most recent policy anniversary.

Tax-free Transfers

Unlike mutual funds and other investments made with “after-tax money,” annuities have no tax consequences if you change how your funds are invested.

Doing this is valuable if you are using a strategy called “rebalancing,” which is recommended by many financial advisors.

With rebalancing, you shift your investments periodically to return them to the proportions that you determine represent the risk/return combination most appropriate for your situation.

Lifetime income

A lifetime immediate annuity converts an investment into a stream of payments that last as long as you do.

Ideally, this stream of payments will come from three “pockets”: Your investment, investment earnings and money from a pool of people in your group who statistically do not live as long as actuarial tables predict.

It’s the pooling that makes annuities unique, and it’s what enables annuity companies to be able to guarantee you a lifetime of income.

Beneficiaries

If you start an immediate lifetime annuity and die soon after that, it’s a misconception that the insurance company keeps all of your investment in the annuity. This could actually happen, but it doesn’t have to.

To prevent it from happening, we suggest you buy a “guaranteed period” with the immediate annuity. A guaranteed period commits the insurance company to continue payments after you die to one or more designated beneficiaries.

The payments continue to the end of the stated guaranteed period which is usually 10 or 20 years (starting from when you began receiving the annuity payments).

Another bonus is that annuity benefits that pass to beneficiaries don’t have to go through probate and aren’t governed by your will.