Annuities FAQs
How do annuities work?
Fixed-rate and variable annuities have two stages: the accumulation period and the payout period. The accumulation period begins as soon as you invest. You invest with one payment if you select a single-premium deferred annuity. Or, you make one or more payments of various amounts to a flexible-premium deferred annuity. Once you make a payment, your money begins to accumulate tax-deferred earnings. Later, your principal and interest are paid out to you in the form of regular income or as a lump sum.
Are annuities a new type of investment?
No. Annuities have been around in this country for over 100 years. They have been available in other counties for several hundred years.
I read somewhere that annuities are a bad idea; is this true?
Absolutely not. However, like any other type of investment, annuities can be misused or improperly represented by an advertisement or adviser. Equally important, just like mutual funds and back CDs, some annuities represent a bad value or have demonstrated poor performance. If you remember hearing about annuities through friends or parents who said they were a bad deal, they ere probably referring to annuities that were offered a couple of decades ago with poor rates of return and noncompetitive provisions – in short, some annuities relied on the ignorance of the investing public. Fortunately, things have greatly changed over the past 25 years.
Why should I purchase an annuity?
There area three good reasons:
1. As a safe vehicle for you money.
2. For tax-deferred growth of earnings.
3. To ensure that your resources last as long as your need them.
Is there more than one type of annuity?
YES. Annuities can be categorized in one of three ways: (1) when they commence payment, (2) what they invest in, and (3) whether money can be added to the contact. An immediate annuity is for someone who wants to start receiving income right away. A deferred annuity would be the right choice for someone who did not need any additional income now, but might in the future, and/or who wanted a growth vehicle. The second way of categorizing annuities is by how the money is invested. When you invest in a fixed-rate annuity, the contract owner receives a set rate of return, similar to a bank CD. Under a variable annuity, the investor portfolios, ranging from conservative (money market account) to speculative (aggressive growth fund). The third way to categorize an annuity has to do with principal contribution(s). A single-premium contract allows for only a onetime deposit. A flexible-premium contract is structured so that additional monies can be added now or in the future.
How do I choose which type of annuity is best for me?
Your firs decision is whether you want a guarantee (fixed-rate annuity) or flexibility (variable annuity) with your investment. Next, determine which contract provisions (e.g., how the free withdrawal is calculated, when the penalty period ends, expense charges, etc.) are important before comparing contracts.
How much money should I invest in an annuity?
The answer to this question depends on you risk level, how your money is currently invested, your time horizon, and current as well as projected tax bracket. It is important to see how annuities fit in as part of an overall financial plan. Like anything else in life, the answer to this question will largely depend on your comfort level and what feels right to you.
Is there an exact way to determine risk?
NO. There are several different tests to help investors to determine their risk profile, but there is not one that clearly stands above the others. Defining risk in precise terms is almost like trying to find a universal definition of love that everyone agrees to – a process that is elusive at best.
Should I avoid annuities since I don’t understand them?
Be patient. The first time you heard about mutual funds of bonds you probably did not understand all of the workings of such investments. Annuities area not difficult to understand.
What makes an annuity better than other investments?
Tax-deferred growth. In addition, an annuity can guarantee you an income stream that you cannot outlive. The daily guarantee of a fixed-rate annuity and the death benefit (or enhanced death benefit) in the case of variable contracts is another benefit. Finally, the ability to make changes without paying income taxes may be the biggest advantage.
What does tax deferral mean to me?
It means you pay no taxes on interest or growth, as long as such earnings remain in the contract. The money that would otherwise go to the government goes to work for you instead – compounding even more. The cumulative effect of this tax deferral can be startling. Your funds grow much faster.
What is often overlooked about an annuity is the income stream that it can later provide. Tax deferred results in greater growth of principal, which can be used to provide an income stream that is far greater than what would have been gained from an investment that was partially or fully taxable each year. Phrased another way, tax deferral does not have to be a ticking time bomb; there is most likely no need to liquidate the contract during your or you spouse’s lifetime.
How does an annuity compare to an IRA for retirement?
Annuities and IRA differ in a number of significant areas. Not everyone can open an IRA – only those with earned income. Anyone can purchase a fixed-rate annuity. When contributing, you are limited to $3000 annually with an IRA; there are no limits with an annuity.
On the tax front, IRA contributions may be deductible, although the law imposes limits based on income and pension-plan coverage. Generally, no deductions are allowed for payments to an annuity. If you are not allowed a deduction for your IRA contribution, an annuity is a smart alternative – your money still grown tax-deferred.
How important is professional management?
When you invest in an annuity you have hired professional management. Individually, you and I cannot afford to hire the top money managers, but collectively we can hire the best. By hiring professionals to manage our money we do not have to worry about the day-to-day fluctuations in the stock and bond market or wonder if the securities purchases are about to be downgraded.
Are there disadvantages to other investments?
Absolutely. There is no such thing as a perfect investment. If there was a perfect investment, you and I would never have to read the financial press or buy another book on investments. Unfortunately, there is no panacea when it comes to investing.
What does the insurance company do with my fixed-rate premium?
The company invests the funds in its investment portfolio and credits interest to your account. This is called the accumulation phase of the contract. It is important during this phase to know that your annuity company manages its investments wisely. You want to choose a company that is highly rated by independent analysts for its ability to meet its obligations. The company should have a strong capital base and a history of high ratings, preferably from at least two well—known services.
Are insurance companies the only ones that offer annuities?
The answer to this question is somewhat confusing. True, it is only the insurance industry that is allowed to create annuities for the public, but other financial institutions, such as banks, brokers, and financial planners, market these products.
Aren’t tax-free exchanges oversold?
You may think that you never want to move your money from a mutual fund, stock, bond, or bank CD, but think again. No one knows where interest rates will be in a couple of years or if a bank may become troubled or when a favored manager may leave a mutual fund. When such an event occurs, you may be reluctant to move your money either due to a sense of safety (comfort level in dealing with the same institution year after year) or because of the tax ramifications.