Annuities

An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.

Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates. If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties.

Two common types of annuities are fixed and indexed. In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

There are advantages to owning an annuity. Tax deferral is not the only advantage of the tax deferred annuity. Another advantage is the privilege of annuitization itself, which allows the annuitant to receive a guaranteed stream of income for life. Alternative investments – stocks, bonds, mutual funds, CDs, etc. – do not provide this feature. CDs are FDIC insured and offer a fixed rate of return if held to maturity. Annuities are not FDIC insured. Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59 are subject to 10% IRS penalty tax. Surrender charges apply. Guarantees are based on the claims paying ability of the issuing insurance company.

The death-benefit feature of the tax deferred annuity, which allows the holder of the annuity to designate a beneficiary to receive any undistributed proceeds in the annuity, is yet another unique advantage. While alternative investments may be bequeathed as part of an estate, the annuity death benefit constitutes life insurance and is therefore exempt from probate. The minimum death benefit is the total amount of payments, less any partial withdrawals.

A tax deferred annuity can be designed with a guaranteed minimum feature, in order to assure the holder of a minimum retirement income from the annuity.
All situations are different and annuities are not right for every person and portfolio.