Annuities are not something new. The Roman Empire used annuities as a way to provide retirement income to the families of soldiers and their families. Some would argue the concept started as far back as 1700 BC in Egypt.
An annuity is a way to save for retirement and supplement your retirement income. Annuities are contractual agreements between the owner of the annuity and an insurance company. You have the option to make a one-time payment or series of payments into the annuity account.
The main objective of an annuity is to provide you, the annuitant, a steady stream of income throughout your retirement years. You enter into a contract with an insurance company whereby you pay the insurer a premium in return for a guaranteed series of payments either for your lifetime or a specified number of years. The payments begin when the annuity is “annuitized.” Annuitization can be immediate or deferred indefinitely.
Annuities involve three parties – the owner, the annuitant, and the beneficiary. The owner and the annuitant can be the same person or different persons, and the owner does not have to be a natural person. The owner controls the annuity and is the only one who can make changes or withdrawals. The annuitant, while living, is the beneficiary. Death of the owner or annuitant (depending on the annuity) triggers payment of the account value to the named beneficiary. The beneficiary receives an income tax-free income payout of the total value.
Annuity payments can begin immediately, as with an immediate annuity, or annuity payments can be deferred. Deferred Annuities have tax advantages that give you time to build your account value. They are called Tax-Deferred Annuities. While deferred, you have not relinquished your principal as a premium payment in exchange for annuity payments. You still own the account value and can withdraw it or roll it into another annuity or life insurance policy. There may be a surrender charge for a specified number of years, but some annuities allow penalty-free withdrawals before the surrender period has ended.
The option of withdrawing principal ends if and when you decide to annuitize. Annuitization means you exchange the account value for a guaranteed series of payments. That decision to annuitize is totally up to the owner of the annuity.
A deferred annuity serves as a tax-deferred saving account with an insurance company. You pay a premium payment, or a series of premium payments into the annuity account and the insurer pays you interest or dividends which are tax-deferred until such time you withdraw the account value. In most cases, the interest-only portion of the annuity account becomes taxable when it’s withdrawn.
The account value can be rolled into another annuity or life insurance policy without tax consequences. That’s because the IRS allows you to directly roll the value into another annuity or life insurance policy with a provision called a 1035 exchange.
Annuities can be qualified or non-qualified meaning they can be used for IRAs. If the annuity is set up as an IRA, the premiums can be deducted from your taxable income. Be aware that withdrawals prior to age 59 1/2 may be subject to a 10% income tax penalty. You should discuss all tax questions with a qualified tax professional.
There are generally two types – fixed annuities and variable annuities
Multi-year guaranteed and indexed annuities are considered fixed annuities. Multi-year guaranteed annuities provide a guaranteed interest rate for a specified number of years, while indexed annuities offer returns linked to stock indices. Multi-year and indexed annuities have guarantees for your principal and earned interest, and there is no investment risk. Your principal and interest are guaranteed. In addition to the guarantees provided by the insurer, State Guarantee Associations provide additional safeguards. These types of annuities are considered safe investments.
Variable annuities link your return (or loss) directly to investment accounts. Variable annuities involve investment risks. An investment advisor must have a Series 6 and 63 securities license to sell variable annuities.
One of the most attractive attributes is being able to customize it to fit your specific income needs. Not only do you have the option to decide how you will fund it, but you can also select if and when, or if, you want to annuitize your account. Deferred annuities do not have to be annuitized at all. Deferral gives you the flexibility to withdraw interest-only or any portion of the annuity value (subject to surrender provisions) or annuitize. The choice is totally up to the owner.