Locking Up Money You May Need
If you suddenly need those funds, it can be difficult to access your annuity investment or cash it out. In some immediate annuities, after investing your principal, you lose access to it even though payments begin immediately. In some cases, you may be able to withdraw your principal or select time periods during which you can do so. But your monthly payment may be smaller. Also, you will usually have a 10% penalty if you withdraw from a deferred annuity before you turn 59 ½.
How Life Insurance And Annuities Can Complement Each Other
There are many different kinds of life insurance. A policy can be temporary or permanent. It may have cash value or not. But the one defining feature of all life insurance policies is a death benefit. Its the most important reason to get a policy, and how it is almost always described: when people say they have a $1,000,000 policy, it means that a $1,000,000 benefit will be paid to their beneficiaries upon their death.
If you are the beneficiary of a life policy, what you do with your share of that benefit is up to you. Insurance companies typically give beneficiaries the choice of getting their payment in one of three different ways:
Example Of An Annuity
A life insurance policy is an example of a fixed annuity in which an individual pays a fixed amount each month for a pre-determined time period and receives a fixed income stream during their retirement years.
An example of an immediate annuity is when an individual pays a single premium, say $200,000, to an insurance company and receives monthly payments, say $5,000, for a fixed time period afterward. The payout amount for immediate annuities depends on market conditions and interest rates.
Annuities can be a beneficial part of a retirement plan, but annuities are complex financial vehicles. Because of their complexity, many employers don’t offer them as part of an employee’s retirement portfolio.
However, the passage of the Setting Every Community Up for Retirement Enhancement Act, signed into law by President Donald Trump in late December 2019, loosens the rules on how employers can select annuity providers and includes annuity options within 401 or 403 investment plans. The easement of these rules may trigger more annuity options open to qualified employees in the near future.
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Your Beneficiaries Will Not Get A Benefit If You Die
Some annuitants select the highest monthly income possible in certain annuities in exchange for zero death benefits for their beneficiaries. This negative can be corrected by purchasing a deferred annuity with a guaranteed lifetime withdrawal benefit. The death benefit will be the annuitys remaining account balance in a lump sum.
Helpful tip: Life insurance might be a good option if you want to leave money to your beneficiaries. You dont have to take a medical examination in some cases. Compare quotes online to see if you can purchase cheap life insurance. Coverage starts at $9.37 per month.
Should I Consider A Fixed Annuity
When deciding if a fixed annuity is a good option for you, here are three important considerations:
- Have a guaranteed rate of return for a specific period of time from 3-10 years
- Making withdrawals prior to the end of a guarantee period may have tax implications and cause you to pay surrender charges
- Over time, renewal rates and fixed-income payments may not keep up with the pace with inflation
- The guarantees provided by any type of insurance contract are based on the claims-paying ability of the insurance company
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Annuities: When Theyre A Bad Investment
Do not purchase an annuity without checking your entire financial picture first. There are some people who sell them with good intentions, but they may not have a complete understanding of what theyre selling. For instance, their understanding of tax issues might be limited. In addition, they cannot see how the product fits into your retirement plan if they havent done any planning for you.
It is also important to be aware of the fees associated with annuities. After all, your returns will be lower if you pay high fees. And, in most markets, you will not earn a lot of money from some annuities due to high fees.
If you do not have a plan in place, never buy an annuity. So, until you have done your research on annuities, you shouldnt feel pressured or obligated to buy one.
You might hear from a sales agent that an annuitys sale will be short-lived. There are times when insurers stop selling specific products, which could explain this. Even so, you should not rush into making a decision. And, always remember that a similar product will likely be available elsewhere.
Special Considerations For Life Insurance
It’s important to know that the use of life insurance as an investment strategy has drawbacks, including high fees. Roughly half of a policyholder’s premiums go toward the sales representative’s commission. Consequently, it takes a while for the savings component of a policy to start gaining traction.
In addition to the upfront costs, policyholders must pay annual administrative and management fees, which can counteract the benefits of the funds’ tax-sheltered growth. Furthermore, it is often unclear what the fees are, making it difficult to compare providers. Sadly, many people let their policies lapse within the first few years because they cannot maintain the steep payment schedules.
Many fee-based financial planners urge investors to purchase lower-cost term insurance policies, then funnel the leftover funds that would have gone toward permanent life premiums into tax-advantaged retirement plans such as 401s or IRAs. This approach lets policyholders pay smaller investment fees, while still enjoying tax-deferred growth in their accounts.
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How An Annuity Strengthens A Financial Plan
A little bit of everything can help a retirement go a long way.
A good plan in retirement generates income from several different sources to help you stay within a desired income tax bracket and shield your savings from a variety of risks. That means an annuity isnât necessarily better or worse than investments in the market. Instead, every financial product fulfills a different need. Investments can generate tax-advantaged growth to stay ahead of inflation and provide the optionality of taxable or IRA) and non-taxable income ) in retirement.
Deferred fixed annuities may not have the upside of an aggressive investment strategy, but they donât need to. Thatâs because an annuityâs job is to hedge longevity and market volatility risk in your portfolio, but they can also be used for tax-advantaged growth. Lifetime guarantees ensure youâll have some money coming in the door no matter how long you live or what happens in markets.
Income annuities, along with Social Security and other guaranteed income sources, provide a floor or safety net for your monthly income that investments alone canât provide. Income annuities bring consistency and reliability to your financial plan, and that goes a long way reducing worries about the future. If youâd like to explore more ways to diversify your income in retirement, reach out to a financial advisor to get a conversation started.
What Is An Individual Retirement Annuity
Youâve probably heard of an individual retirement account. This account lets you save for retirement in a tax-advantaged way. Itâs typical for people to use investments within an IRA. But the truth is that you can hold other types of financial tools in an IRA, including an annuity. Annuities that are used to fund IRA accounts are sometimes called individual retirement annuities.
If an annuity is used to fund an IRA, all IRA contribution and tax rules apply however, itâs important to note that if an annuity is used to fund an IRA account, there is no additional tax benefit provided by the annuity.
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Why Do People Buy Annuities
People typically buy annuities to help manage their income in retirement. Annuities provide three things:
- Periodic payments for a specific amount of time. This may be for the rest of your life, or the life of your spouse or another person.
- Death benefits. If you die before you start receiving payments, the person you name as your beneficiary receives a specific payment.
- Tax-deferred growth. You pay no taxes on the income and investment gains from your annuity until you withdraw the money.
Tax Deferral On Investment Earnings
Many investments are taxed year by year, but the investment earningscapital gains and investment incomein annuities arent taxable until the investor withdraws money. This tax deferral is also true of 401 s and IRAs however, unlike these products, there are no limits on the amount one can put into an annuity. Moreover, the minimum withdrawal requirements for annuities are much more liberal than they are for 401s and IRAs.
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Exchanging Or Replacing Your Current Annuity
If you already have an annuity, you may be presented with an option to exchange or replace it. If you consider exchanging or replacing your annuity, be sure to do a close comparison with your existing annuity, and only make a change when it is better for you, not just better for the person trying to sell you a new product. Remember that exchanging one contract for a new one may involve additional costs and fees and usually means the clock restarts for purposes of early withdrawal penalties.
An investor considering an exchange of a fixed annuity for a variable annuity should be aware that, unlike a fixed annuity, a variable annuity lacks certain guarantees and can be affected by fluctuations in the market. Also, with the addition of benefits , certain variable annuities can be more expensive than fixed annuities.
If you do exchange your annuity, there can be benefits to what is called a “1035 exchange,” which refers to a provision in the U.S. tax code that permits a direct transfer of funds in a life insurance policy, endowment policy or annuity policy to another policy without tax consequences.
Do Annuities Have High Fees
Despite the misconception, there are some annuities with low fees. There are some annuities sold by investment companies without sales commissions or surrender charges, known as direct-sold annuities. Also, annuities can be purchased from a variety of brokerage firms at a low price. For more information, you should contact a financial advisor.
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What Is An Annuity
An annuity is a customizable contract issued by an insurance company that converts an investors premiums into a guaranteed fixed income stream.
More specifically, an annuity contract is a legally binding, written agreement between you and the insurance company that issues the contract. This contract transfers your longevity risk the risk of you outliving your savings to the insurance company. In exchange, you pay premiums as outlined in the contract.
What Are The Drawbacks To Annuities
The majority of people can benefit from annuities. But they also have some drawbacks to be aware of.
The major concerns are long-term contracts, losing control over your investment, and low or no interest earned. Other possible disadvantages are the fees and complexity. In addition, annuities have fewer liquidity options, and you have to wait until age 59 ½ before withdrawing money from them.
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Fixed Vs Variable Annuities
In a fixed annuity, the insurance company guarantees the principal and a minimum rate of interest. In other words, as long as the insurance company is financially sound, the money you have in a fixed annuity will grow and will not drop in value. The growth of the annuitys value and/or the benefits paid may be fixed at a dollar amount or by an interest rate, or they may grow by a specified formula. The growth of the annuitys value and/or the benefits paid does not depend directly or entirely on the performance of the investments the insurance company makes to support the annuity. Some fixed annuities credit a higher interest rate than the minimum, via a policy dividend that may be declared by the companys board of directors, if the companys actual investment, expense and mortality experience is more favorable than was expected. Fixed annuities are regulated by state insurance departments.
Money in a variable annuity is invested in a fundlike a mutual fund but one open only to investors in the insurance companys variable life insurance and variable annuities. The fund has a particular investment objective, and the value of your money in a variable annuityand the amount of money to be paid out to youis determined by the investment performance of that fund. Most variable annuities are structured to offer investors many different fund alternatives. Variable annuities are regulated by state insurance departments and the federal Securities and Exchange Commission.
Annuities Can Be Complicated
Some annuities are too complex for many to understand without help from a financial professional.
Unlike other retirement payment plans, an annuity has the most complicated structure, Stewart said. Generally, insurance companies might sell the most attractive package, which is the lifelong benefits however, the high taxes and the payment calculations are grossly misunderstood by retirees.
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What Is The Surrender Period
The surrender period is the amount of time an investor must wait before they can withdraw funds from an annuity without facing a penalty. Withdrawals made before the end of the surrender period can result in a surrender charge, which is essentially a deferred sales fee. This period generally spans several years. Investors can incur a significant penalty if they withdraw the invested amount before the surrender period is over.
Lifetime Vs Fixed Period Annuities
A fixed period annuity pays an income for a specified period of time, such as ten years. The amount that is paid doesnt depend on the age of the person who buys the annuity the payments depend instead on the amount paid into the annuity, the length of the payout period, and an interest rate that the insurance company believes it can support for the length of the pay-out period.
A lifetime annuity provides income for the remaining life of a person . A variation of lifetime annuities continues income until the second one of two annuitants dies. No other type of financial product can promise to do this. The amount that is paid depends on the age of the annuitant , the amount paid into the annuity, and an interest rate that the insurance company believes it can support for the length of the expected pay-out period.
With a pure lifetime annuity, the payments stop when the annuitant dies, even if thats a very short time after they began. Many annuity buyers are uncomfortable at this possibility, so they add a guaranteed periodessentially a fixed period annuityto their lifetime annuity. With this combination, if you die before the fixed period ends, the income continues to your beneficiaries until the end of that period.
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Qualified Vs Nonqualified Annuities
A qualified annuity is one used to invest and disburse money in a tax-favored retirement plan, such as an IRA or Keogh plan or plans governed by Internal Revenue Code sections, 401, 403, or 457. Under the terms of the plan, money paid into the annuity is not included in taxable income for the year in which it is paid in. All other tax provisions that apply to nonqualified annuities also apply to qualified annuities.
A nonqualified annuity is one purchased separately from, or outside of, a tax-favored retirement plan. Investment earnings of all annuities, qualified and non-qualified, are tax-deferred until they are withdrawn at that point they are treated as taxable income .
Is An Annuity A Good Investment
To determine whether an annuity is a good investment, you must consider your personal investment needs and goals. Its also important to account for factors like your age, risk tolerance and lifestyle.
Generally, the younger you are, the more risk you can tolerate. In this case, you might invest in products with greater growth potential. The returns on annuities are modest compared to stocks and other investment vehicles, but they offer guaranteed growth over an extended period.
Annuities tend to be sound investments for older consumers preparing for retirement. The modest returns annuities provide are balanced out by principal protection and tax-deferred growth. Annuities also provide a stream of income you cant outlive, unlike other retirement solutions.
When deciding whether to invest in an annuity, weigh which characteristics of a savings vehicle are most important to you. If you want a safe investment that allows your money to grow tax-deferred and gives you the option to pass on your investment to a beneficiary, an annuity might be the right choice.
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