What is an Annuity and should I buy one?
An annuity is a contract with a financial institution such as an insurance company. In exchange for the money you give them, they are contracted to make regular payments to the annuitant on an annual, semi-annual, quarterly, or monthly basis. This is an ideal contract for retirement. Another ideal person who may consider an annuity is a person who has a large sum of money that needs a safe place for their money. To either be paid immediately or to defer the payments to a later date. One of the best things about an annuity is that virtually anyone can get a contract.
The funding of the annuity is considered to be the accumulation phase. Those funds are from a large lump sum of money as I mentioned earlier or by making regular payments to a financial institution. Usually an annuity is for retirement so, unlike IRA's and 401K's you are not limited to how much you can contribute to the annuity.
The annuitization phase is when the annuity starts to make those payment based on the options you chose. During this period you have a few options. You can choose what is called a Life option which will pay you for your entire life. There is also a Joint-life option which will continue the payments until your spouse passes away. There is Period certain which will make payments for a specific amount of time such as 5, 10, 15, 20 years etc. If you should pass away before your period has ended, the remaining funds will go to your beneficiary. You could choose a Lump Sum withdraw but keep in mind the payment would be much lower if you choose this option than if you allowed the payments to pay out over time.
Always remember that all of these products has fees associated to them. Things like riders could eat away at the cash value of your annuity. Be very cautious when exploring these options and be sure to ask your agent as many question as you need to fully understand these.
Types of Annuities
Annuities has many flowing parts that can be tailored to your specific needs. Knowing that annuities are usually retirement products, they are not always. Do you remember us talking about the lump sum payment during the accumulation phase? Well, these are good for immediate payment annuity. An immediate payment annuity is just that. It starts regular payments immediately. You do not have to be a certain age to take advantage of these products. However, if you defer payments a little while longer you have the potential of having a larger payout. This is known as the Deferred income annuity. Under the Deferred income annuity, lets discuss the Fixed Annuity ,Variable Annuity, Index Annuity. All of which payments and taxes are deferred.
Fixed Annuity are great ways to guarantee income in retirement. From inception of the contract you know exactly when you will start receiving payments. How much the payments are for and for how long. The gains on these funds are tax deferred. You will not pay taxes until you start the annuitization phase. The financial institution can make these guarantees because your rate of return is based on the yield that they generate from their investment portfolio. Which is usually high-quality corporate and government bonds. Despite the performance of those investments the financial institution is responsible for paying the rate of return promised in the contract.
Variable Annuity on the other hand is another beast. They are also tax deferred. But, these are based on the performance of the mutual funds they are tied to. These do not provide you with the guarantees that the fixed annuities does. Despite that these annuities could potentially gain much higher returns, but takes the risk of losing some or even all of your principle. Variable annuities are usually sold by financial advisers due to their potential of loss. An insurance agent can not sell you one of these unless they posses the security license. These are good if you are a little more risky with your money.
An Index Annuity is like a hybrid of the fixed annuity and the variable annuity. You participate in the upside of the market, up to a cap. But do not participate in the downside of the market. There's a zero floor. Your gains are locked into place. Index Annuities uses the index market such as the S&P 500 to credit your cash value account. You are not directly participating in the market. So, that means if the market does bad that year, you will not receive any credit to the cash value. This is great because you can not lose your principle in the market. Please keep in mind there are still fees and any riders that needs to be paid in those bad years. The type of person these are good for is someone who is not afraid of minimal risk. A person who still want to participate in market like gains.
It is important to decide if an annuity is right for you before signing on the dotted line. You will get a free 10 day look period, where you can cancel the annuity without any penalty. This is due to the surrender period. After the 10 days has passed and you decide to cancel the annuity you will incur hefty fees and taxes. Not just from the financial institution, but also from the IRS. You should plan not to have those annuity payments for a minimum of 3 - 10 years, depending on your contract. You will only have the free look period for the immediate annuity as well. You can not ask for your original principal back without inuring fees after that period.
Deferred annuities are for retirement. The IRS will impose a 10% penalty plus ordinary income tax on the gains of the annuity if you withdraw the money before 59 and half. As long as you have passed the surrender period, you will not incur any more fees from the financial institution if you withdraw early.
An annuity is an amazing way to safeguard your money and protect it from market loss. You have so much flexibility that you would need to choose for your annuity. Be sure to think about the purpose of the annuity and how much you are wanting to safeguard. Are you risky, a little, or not? When would you want the payments to start? How long will you want to receive payments. Remember riders add fees to your annuity be careful on what you choose and is it worth it in your situation. If you are just looking for a safeguarded place to store some money for retirement. Then an annuity is an amazing solution. Please let us know how we can help you?