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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 Most modern annuities can be withdrawn in periodic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are paid on the interest accumulation in an annuity until money is withdrawn by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 with 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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