An Annuity is a contract between you and an insurance company that allows your earnings to grow and compound tax-deferred. This a powerful benefit that you can use to help you accumulate wealth for your retirement or other long-term financial goals.
There are two main annuity types: deferred and immediate.
With an immediate annuity, your income payments start right away. You choose whether you want income guaranteed for a specific number of years or over your lifetime. The insurance company calculates the amount of each income payment based on your purchase amount and your life expectancy.
A deferred annuity can have two phases: the accumulation phase and the payout phase. During accumulation: your money grows tax deferred until withdrawn, either as a lump sum or as a series of payments. You decide when to take income from the annuity and therefore, when to pay taxes.
The payout phase begins when you withdraw income from your annuity. For most people, this is during retirement. As your needs dictate, you can take partial withdrawals, completely surrender your annuity, or convert your annuity into a stream of income payments.
Fixed and variable annuities differ in the way they generate earnings and also in the amount of risk.
When you buy a fixed annuity, the insurance company guarantees you an interest rate for an initial period of time. At the end of this period the company will declare a renewal interest rate. In addition, most fixed annuities have a minimum interest rate that is guaranteed for the life of the contract. Fixed annuities typically appeal to investors who feel more comfortable knowing exactly how much their money is worth and earning.
With a variable annuity, you have added control over the investment dollars. You allocate your funds among a variety of investment options with objectives ranging from aggressive to conservative. Your rate of return is tied to the performance of the underlying investments of the sub-accounts. Variable annuities typically appeal to investors who are willing to accept a higher level of risk for a higher growth potential.
The most popular income options are:
- “Life Only or Straight Life” – Income payments are guaranteed for as long as you live. At death, income payments stop. This option may be a good choice if you think you will live longer than the average life expectancy.
- “Period Certain” – income payments are guaranteed for a specific period of time. If you die before the end of the “period certain,” payments continue to your beneficiary(ies).
- “Life with Period Certain” – Income payments are guaranteed for a specific number of years, plus, payments continue beyond the “period certain” for as long as the annuitant lives.
- “Joint and Survivor” – Based upon the lives of two people, the income payments continue until the death of both annuitants.
- “Cash or Installment Refund” – at the death of the annuitant, payments either continue until the principal has been returned in full or a lump sum is paid.
When you buy an immediate annuity or “annuitize” a differed annuity, a portion of each payment is considered earnings and a portion is a tax-free return of your principal. You are only subject to regular income tax on the portion of each payment that represents earnings. Once enough payments have been made that you have recovered all of your tax free principal, each additional payment will be fully taxable.
- Annuitant – The individual upon whom the contract’s life and benefits are based.
- Beneficiary – The person or persons named by the owner to receive the death benefit
- Exclusion Ratio – A tax term that means that a portion of each annuity payment is excludable from gross income
- Front End Load – An expense charge made at the inception of an annuity contract
- Guaranteed Interest Rate – In a fixed annuity, the minimum interest rate that is guaranteed by the insurance company to be credited each year to the cash value
- Market Value Adjustment (MVA) – An account adjustment that reflects the impact of any change in interest rates from the time the guarantee period was selected. Lower rates produce a positive adjustment, while higher rates produce a negative one
- Surrender Charge – A charge made for a partial or full withdrawal from an annuity contract before the annuity starting date; often scales down over time.
Source: Western & Southern Financial Group/National Integrity Life Insurance Company
- Guarantees are based on the claims-paying ability of the issuing insurance company.
- Guarantees do not apply to the investment return of principal value of the separate accounts of variable annuity products.
- Variable annuities are long term investments; withdrawals prior to 59 1/2 years are subject to a 10% penalty.
- Variable anniities are subject to additional fees and charges.