All Things Annuity

The intent of annuities is retirement:


Annuities are most efficient when they are used to supplement income once the owner is retired. The idea that these products grow in an account, tax deferred, with a plausible rate of return, is very conducive to many clients’ retirement goals. The tax-deferral benefits of annuities are most valuable for those in the highest tax brackets who have already met contribution limits in tax-advantaged retirement accounts. On average, these are middle-aged people approaching retirement.


To strengthen the point that annuities are a retirement vehicle, the government will garnish 10% of the accumulation value if the annuitant decides to opt out of the contract before age 59 ½. Along with the 10% taken, the remaining balance on the policy is still subject to normal income taxation.


The cost structure of annuities also heavily favors retirement planning. Most annuities carry surrender charges, which vary in size and duration. The charges may be 7-9% for the first two years after purchase, then decline steadily over the remaining term of the annuity “life”. Duration may exceed ten years but usually does not.


Most of these retirement-based features make annuities an “implausible” choice for young investors. Beginning investors often have short term investment goals, like liquidating mortgages and funding children’s education. Their income is likely to be at its lowest point, since they are just entering the job market. This limits their retirement saving to whatever they can afford to contribute to tax-advantages plans such as IRAs and 401k plans. They also have a need for liquidity to cope with the inevitable emergencies of life.


You could make a good case for annuity investment by middle age and older adults, all the way into retirement itself. There is an equally solid case against annuity investment by young adults (ages 20-35). One plausible exception to these general age criteria might be young professionals and business owners who need a shield against liability judgments.


Figure out how much risk you want to take with your money


Studies have shown that the value of annuitization goes up tremendously as investor risk tolerance decreases. Therefore, an immediate annuity is great way to counteract the risk of outliving your income. Deferred fixed annuities and CD annuities are proper for patrons who want to avoid the risk of equity markets. Indexed annuities offer the chance for larger returns at the risk of more unpredictability; they are also a substitute for equity investments. Deferred variable annuities merge potential high returns of mutual funds with tax deferral; they are perfect for high income individuals in middle age who need more development but have used up their allowable tax-advantaged contributions.

Make sure you’re working with a high quality company and high quality product


Most annuities are written by insurance companies, which offer both asset and income linked promises. The fiscal state of the issuing insurance company underwrites the guarantees, which makes it worthwhile for an annuity customer to limit purchases to products of financially-sound insurance companies. The four major rating agencies provide ratings for life-insurance companies. It is wise for a potential annuity purchaser to choose only highly-rated companies. Each rating system is somewhat different than the others, but all of them explain their ratings articulately.


This step is very important. A very risk-averse investor who annuitized most of their assets, only to see the value of the annuity annihilated when the insurance company went kaput, would suffer a crushing loss. It is fact that insurance companies rarely declare bankruptcy and a measure of endorsement is provided by state guaranteed funds, as well as by the acquisition of sick companies by healthy ones. Nevertheless, you should solidify your position by checking on the financial-soundness rating of any carrier whose annuity you are considering.
Investigate all of your options


Economic reliability is not the only motive to review rival annuity products before purchase. Annuities are well-known for the number and intricacy of their features. Payouts, death benefits, rate-of-return and income guarantees, number and variety of sub-accounts, ability to transfer funds between alternative investments, withdrawal provisions, and surrender-charge waivers are among the annuity benefits that vary across, and within, insurance companies.


Shopping will have an even bigger bonus in the cost area. Surrender charges are a customary drawback of annuities, but today it is possible to find annuities that have no surrender charges. High costs and fees are another traditional concern, but low-cost and no-load annuities have increased in number.


Not surprisingly, rule number one of annuity shopping is to read the annuity contract carefully and thoroughly.


Make sure you are purchasing an annuity for the right reason


Studies have shown that only an incredibly small portion of annuities are really annuitized. The majority of Americans use annuities to accumulate and grow investment funds rather than to provide lifetime income.


This is very incongruous, since originally, annuities were used to distribute even payments that were guaranteed for life. The word “annuity” refers to the lifetime stream of level payments rather than to the wealth accumulation vehicle that financed it. The reasons for this low rate of annuitization are open to argument. Part of the answer seems to be the fact that a large lump of retirement-directed assets are already “annuitized” by the Social Security system and private pensions. Another reason seems to be the loss of power involved in surrendering wealth to the annuitization process.


Two factors should cause Americans to reconsider their stance on annuitization. First, life expectancies have been progressively increasing over the last 100 year. This worsens “longevity risk” – the hazard of running out of cash before running out of time. Retirement investors are increasingly contemplating the need to increase their exposure to equity investment in order to augment their rate of return, so as to build up enough wealth to last for a longer lifetime. Moreover, the realized rate of return on an annuity increases the longer one life, which makes annuities a better bet in an era of increasing life expectancies.


This highlights the role played by the second factor. The recent economic disaster has apparently roused the inner conventionalism in many investors, driving them to less volatile, more secure investments. This suggests that plain asset reallocation in favor of equities will not solve the problem of permanence risk for those people who have become more risk reluctant.


Annuities can be one solution to both of the foregoing problems – provided that investors take good annuity advice. Follow the general principles outlined above and you’ll be doing just that.

Visit our website for more information on fixed annuities.

What is the difference between a “qualified” and “non-qualified” annuity?

The IRS looks at funds in terms of qualified or non-qualified, in order to determine that money’s tax-ability. If money is non-qualified, that means it is not part of a tax-deferred account. Examples of tax deferred account are traditional or Roth individual retirement account (IRA), a simplified employee pension (SEP) or an employer sponsored defined benefit plan such as a 401(k). Taxes have already been paid on non-qualified money. Examples of non-qualified accounts are simple savings, money market accounts, or inheritance.
Qualified Funds

Qualified Funds are moneys eligible to be placed in tax deferred wealth accumulation vehicle that is approved by the IRS. It is important to note that the money placed in one of these accounts must be earned income. One of the major benefits of annuities is that the money that qualified money that is placed in an annuity is often subject to lower tax liability due to the fact that that it is tax deductible. The distribution of income and the taxes paid are deferred until a later point in time, most often after the owner of the annuity has retired.

Qualified accounts do not allow you to take your money until you are age 59 ½. If the account holder does so, it is standard procedure that the IRS will take 10% of the account’s value, and the account is still subject to normal taxation after that point (as yearly income).

One drawback for investors is that income taxes are typically higher than capital gain taxes. The IRS views all income taken from qualified accounts as income for that year, and thus, is taxed at a higher percentage than it would be as a capital gain.

Non-Qualified Annuities: Immediate and Deferred

Funding for a non-qualifies immediate annuity typically comes from the rollover of a single premium (one-time payment). Since that money has already been taxed, the only portion of the policy that is eligible for taxation is the wealth accumulation on it. Therefore, this option makes the most sense for a recent retiree who is looking to immediately take income on their policy.

Non-Qualified variable annuities function in a much different way. The money that is invested in the policy is placed specific stocks, bonds, etc. that are chosen by the annuitant. The gains do not incur any taxation until that income is taken by the policy holder. This also differs from other financial investments that are purchased with after tax dollars. For example, the interest earned on a savings or money market account funded with after tax dollars is not tax-deferred.

The biggest advantage of a tax-deferred account is the fact that potential accumulation will be at its maximum due to the fact that the policy is not incurring income taxes. The second benefit is that the annuitant will most likely be in a lower tax bracket once they retire and start taking income, so the policy will be taxed at a lower percentage.
Purchasing a non-qualified variable annuity can also provide an additional retirement savings advantage for an investor who has already contributed the maximum dollar amount allowed to a qualified plan. The income on variable annuities is susceptible to market fluctuation, though, so there is risk involved. A client looking for a guaranteed monthly stream is better off purchasing a non-qualified immediate annuity.

There is not a limit on the amount of non-qualified money that can be placed in an annuity or the amount of annuities that can be purchased. It is important to be advised that annuities are not considered to be a “liquid” investment, so the purchase should be made with money you are comfortable without, at least in the short term.
Both non-qualified and qualified annuities can be important pillars in a balanced financial portfolio. The idea is to be able to see the effects that the accumulation and distribution periods will have on the long term financial goal structure. Setting clear retirement goals and working with a certified financial planner can aid a policy holder to purchase the product most suited for their financial situation. Investors are encouraged to read the annuity fine print carefully and consult a tax advisor before making any serious purchases.

Annuity Surrender

A surrender charge is a cost incurred by an annuitant cancelling their annuity prematurely. Standard procedure is that an annuity will have a contract life of somewhere between 6 and 10 years. The surrender charge is based on the amount of time that the annuity has been in the client’s possession (the longer the annuitant has had the annuity, the lower the surrender charge).

Visit our website for more information on fixed annuities.