Financial Intel Monthly

Annuity Basics

May 14, 2019 2:29:01 PM / by The Retirement Group (800) 900-5867

.An annuity is a contract
between you, the purchaser or owner, and an insurance company, the annuity
issuer. In its simplest form, you pay money to an annuity issuer, and the
issuer pays out the principal and earnings back to you or to a named
beneficiary. Life insurance companies first developed annuities to provide
income to individuals during their retirement years.

Annuities are either
qualified or nonqualified. Qualified annuities are used in connection with
tax-advantaged retirement plans, such as 401(k) plans, Section 403(b)
retirement plans (TSAs), or IRAs. Qualified annuities are subject to the
contribution, withdrawal, and tax rules that apply to tax-advantaged retirement
plans. One of the attractive aspects of a nonqualified annuity is that its
earnings are tax deferred until you begin to receive payments back from the
annuity issuer. In this respect, an annuity is similar to a qualified
retirement plan. Over a long period of time, your investment in an annuity can
grow substantially larger than if you had invested money in a comparable
taxable investment. Like a qualified retirement plan, a 10 percent tax penalty
on the taxable portion of the distribution may be imposed if you begin
withdrawals from an annuity before age 59½. Unlike a qualified retirement plan,
contributions to a nonqualified annuity are not tax deductible, and taxes are
paid only on the earnings when distributed.

Four parties to an annuity contract

There are four parties to an annuity
contract: the annuity issuer, the owner, the annuitant, and the beneficiary.
The annuity issuer is the company (e.g., an insurance company) that issues the
annuity. The owner is the individual or other entity who buys the annuity from
the annuity issuer and makes the contributions to the annuity. The annuitant is
the individual whose life will be used as the measuring life for determining
the timing and amount of distribution benefits that will be paid out. The owner
and the annuitant are usually the same person but do not have to be. Finally,
the beneficiary is the person who receives a death benefit from the annuity at
the death of the annuitant.


Two distinct phases to an annuity

There are two distinct phases to an annuity:
(1) the accumulation (or investment) phase and (2) the distribution phase.

The accumulation (or investment) phase
is the time period when you add money to the annuity. When using this option,
you'll have purchased a deferred annuity. You can purchase the annuity in one
lump sum (known as a single premium annuity), or you make investments
periodically, over time.

The distribution phase is when you
begin receiving distributions from the annuity. You have two general options
for receiving distributions from your annuity. Under the first option, you can
withdraw some or all of the money in the annuity in lump sums.

The second option (commonly referred to
as the guaranteed income or annuitization option) provides you with a
guaranteed income stream from the annuity for your entire lifetime (no matter
how long you live) or for a specific period of time (e.g., 10 years).
(Guarantees are based on the claims-paying ability of the issuing insurance
company.) This option generally can be elected several years after you
purchased your deferred annuity. Or, if you want to invest in an annuity and
start receiving payments within the first year, you'll purchase what is known
as an immediate annuity.

You can also elect to receive the
annuity payments over both your lifetime and the lifetime of another person.
This option is known as a joint and survivor annuity. Under a joint and
survivor annuity, the annuity issuer promises to pay you an amount of money on
a periodic basis (e.g., monthly, quarterly, or yearly). The amount you receive
for each payment period will depend on how much money you have in the annuity,
how earnings are credited to your account (whether fixed or variable), and the
age at which you begin the annuitization phase. The length of the distribution
period will also affect how much you receive.


When is an annuity appropriate?

It is important to understand that
annuities can be an excellent tool if you use them properly. Annuities are not
right for everyone.

Nonqualified annuity contributions are
not tax deductible. That's why most experts advise funding other retirement
plans first. However, if you have already contributed the maximum allowable
amount to other available retirement plans, an annuity can be an excellent
choice. There is no limit to how much you can invest in a nonqualified annuity,
and like other qualified retirement plans, the funds are allowed to grow tax
deferred until you begin taking distributions.

Annuities are designed to be long-term
investment vehicles. In most cases, you'll pay a penalty for early withdrawals.
And if you take a lump-sum distribution of your annuity funds within the first
few years after purchasing your annuity, you may be subject to surrender
charges imposed by the issuer. As long as you're sure you won't need the money
until at least age 59½, an annuity is worth considering. If your needs are more
short term, you should explore other options.


Tags: The Retirement Group

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