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Annuities

Annuities are contracts issued by insurance companies which allow investors to defer taxation on investment income until withdrawal. Most modern annuities can be withdrawn in periodic payments or a lump sum, providing additional tax deferral opportunity. No taxes are paid on the interest accumulation in an annuity until money is withdrawn by the owner. The government allows annuities this favored tax savings to promote Americans to save! With this privilege of tax deferral also comes an understanding that money placed into an annuity is primarily for long term savings.

Common Types of Annuities:

Fixed Tax Deferred Annuity

What is a Fixed Tax-Deferred Annuity?

A Fixed Tax-deferred annuity, also referred to as a tax-deferred annuity, is a contract between you and an insurance company for a guaranteed interest bearing policy with guaranteed income options. The insurance company credits interest, and you don't pay taxes on the earnings until you make a withdrawal or begin receiving an annuity income. Your annuity contract earns a competitive return that is very safe. These are similar to bank CDs, except that you don't pay taxes on your earnings until withdrawal. This tax deferral can amount to large savings over a bank CD.

Tax-Deferred?

Tax-deferred means postponing your taxes on interest earnings until a future point in time. In the meantime you earn interest on the money you're not paying in taxes. You can accumulate more money over a shorter period of time, which ultimately will provide you with a greater income.

Savings Advantages

Many people today are using tax-deferred annuities as the foundation of their overall financial plan instead of certificates of deposit or savings accounts. Although CD's and Annuities are very similar there are significant differences between the two. The most important difference is that annuities allow for the deferral of the taxes due on the interest earned until the interest is withdrawal! By postponing the that tax width a tax-deferred annuity, your money compounds faster because you can earn interest on dollars that would have otherwise been paid to the IRS. Later, if you decide to take a monthly income, your taxes can be less because they will be spread out over a period of years. Like Certificates of Deposits, annuities have a penalty for early surrender, however most annuity contracts have a liberal withdrawal provisions.

Single Premium Immediate Annuity

What is a Single Premium Immediate Annuity?

A Single Premium Immediate Annuity is a contract between you and an insurance company. By paying in a lump sum of money you are guaranteed to receive a series of payments over a period of time. The amount of the payment is determined by both the current interest rate at the time your contract is issued and by choices you make from a wide variety of payment options. Once your contract is issued, your payments are fully guaranteed for the period of time you have chosen.

Tax-Favored Income?

If you use after-tax funds to purchase a single premium immediate annuity, the income payments you receive are only partially taxable. The non-taxable portion of each payment is a level percentage that represents the return of principal over the life of the contract. Depending on your age and the payment option you chose, this percentage will vary. If you are using tax-qualified funds (IRA, TSA, 401k money for example) to purchase your Single Premium Immediate Annuity, the payments you receive are generally fully taxable as you receive them because they represent funds that have not been taxed before.

Single Premium Immediate Annuities offers a variety of options so you may taylor your income schedule to suit your needs. You can chose to receive payments, monthly, quarterly, semiannually or annually. The payment options include:

  • Period Certain Only
    Period Certain means a number of years you chose. Payments will continue for the duration of the number of years you chose, and then cease. If you should die before the end of the stated number of years, your beneficiary would continue to receive the payments for the remainder of those years.

  • Life Only
    Payments will continue for the rest of your life. You cannot outlive your income. Upon your death, payments stop.

  • Life and Period Certain
    Life and period certain means payments will continue for the rest of your life, but for no less than the stated number of years. If you should die before the end of the stated number of years, your beneficiary would continue to receive the payments for the remainder of those years.

  • Life Only with Guaranteed Minimum Option
    Payments will continue for the rest of your life. If you should die before you have been repaid your initial investment, the balance of your initial investment will be paid in like installments to your beneficiary.

  • Joint and Survivor
    Payments are guaranteed during the lifetime of two people. After the death of one, payments continue for the lifetime of the surviving person. You can chose to have either full payments, or a percentage you chose, to continue for the lifetime of the survivor. You can also specify a period certain, and if both individuals were to die within the period certain, payments would continue to the named beneficiary for the remainder of the period certain.

Tax Sheltered Annuity

What is a Tax Sheltered Annuity?

A tax-sheltered annuity, or TSA, is a long term retirement plan that provides a systematic, tax sheltered way to accumulate funds for retirement.
If your work for a school or other qualifying teahouse organization covered under IRC Section 501(c)(3) you can accumulate money for your retirement in a special tax sheltered plan - a 403(b) Tax Sheltered Annuity.

A TSA reduces your current taxable income.
TSA contributions are excluded from your current taxable income and the interest earned or capital gains credited to your account are tax deferred until you begin to receive distributions from your TSA. The IRS has created a formula known as the Maximum Exclusion Allowance which governs the maximum contribution that you may make to as TSA in a given year.

A TSA offers a high degree of financial security.
TSA's are commonly offered in the form of fixed annuities or equity index annuities. These TSA's are guaranteed to earn no less than a guaranteed minimum interest rate stated in the annuity contract. The fixed annuities are backed by the general account of the insurance company.

Having a TSA doesn't reduce other retirement benefits?
You receive TSA benefits in addition to your pension benefits. Social Security credits are not affected because they are determined by your gross earnings prior to TSA contributions.

Variable Annuities

Variable Annuities provide the advantages of traditional fixed annuities with the potential returns that are available by investing your money in the stock market. The investment options that you may chose from in a variable annuity are referred to as sub accounts. These sub accounts are structured as either mutual funds or as segregated investment portfolios that are managed by professional investment managers.

Family of Funds
Many variable annuities offer more than one family of funds to chose from and within each family of funds you many chose from a variety of funds with different investment objectives. This allows you to diversify your investment portfolio to minimize risk and maximize your potential investment return. Unlike fixed annuities with guaranteed protection against loss of principal, your principal is at risk and subject to loss in value.

Equity Index Annuities

Equity Index Annuities are relatively new in the investment world. These annuities are a hybrid of fixed and variable annuities.

The Equity Index Annuity Offer:

Guarantee - No Loss Provision

  • This means that once you make a premium payment you will never have less in your account than your premium payment.
     

  • This means that once interest has been credited to your equity index annuity the value of your annuity will never decrease unless you make a withdrawal even if the stock market goes down.

     

Long term stock marker growth

  • This means that the Interest Rate set by the insurance company at the end of each policy year is based on the performance of the S&P 500 Index. The method by which the interest rate is calculated and the percentage of the gain of the S&P 500 Index that is credited to your annuity is referred to as the Participation Index Rate.

Glossary of Terms

The following are terms used in describing what an Equity Index Annuity is and how the interest rate is calculated.

  • Standard & Poors 500 - This is an index which was devised a number of years ago by the Standard & Poor's Company. Today the S&P 500 Index is widely regarded as the benchmark index by which U.S. stock market performance is measured.
     

  • Index Average - Instead of using the percentage change over the policy year some companies use an averaging method. They calculate the change by averaging the daily closing S&P 500 values or the monthly S&P 500 values. The averaging method also tends to lower the overall rate of return of the S&P 500 Index, similar to that of a "cap". In rising markets the averaging method limits the increase that would be credited to your annuity policy.
     
  • Highwater Method - Companies that use this method take the value of the S&P 500 Index on the day your policy is issued and subtract that value from the highest value the S&P 500 reaches during the term of your contract. The term of the most commonly used are 5 and 7 year durations. The difference between the value of the S&P 500 on the day you purchased your policy and the highest value reached is converted to a percentage. The amount of money you initially deposited in your policy is multiplied buy their percentage change to arrive at your contract value.


"Standard & Poor's", "S&P 500", "Standard & Poor's 500" and "500" are trademarks of The McGraw-Hill Companies, Inc. and have been licensed for use by companies offering Equity Index Annuities. The product is not sponsored, endorsed, sold or promoted by Standard & Poor's and Standard & Poor's makes no representations regarding the advisability of purchasing the product.

As you can see there are many types of annuities. Although the basic structure of annuities is fairly uniform throughout the industry each company designs their own product. Because of this products vary widely and we recommend you visit with a specialist to see if an annuity is right for you.

 

 

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