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What is an annuity? An annuity is different from most other retirement savings vehicles — it's actually a contract between you and an insurance company. In return for making one or more premium payments, the insurance company agrees to provide you an income stream — usually during retirement. You can elect to receive payment all at once or as a series of payments, even for the rest of your life. An annuity is a contract between you and an insurance company, under which you make purchase payments to the insurance company during the “accumulation period” and the insurance company agrees to make periodic income payments to you, either beginning immediately or at some future date, during the “income period” (also known as “annuitization”). You may select the date on which income payments are to begin (the “annuity date”).
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An annuity converts a lump sum, which is usually a retirement fund or pension lump sum, into a regular guaranteed retirement income that will last for the rest of your life. No matter what. Your income from annuity is taxable and the amount that you get each year will depend on the size of your initial annuity lump sum. It will also vary according to the best annuity rates the annuity company or annuities provider offers, your gender, age and health, and the type of annuity that you opt for. You can take advantage of our annuities calculator to get an idea of how much retirement income you are likely to generate. If you are lucky enough to have had one of the with profits pensions funds, and you choose a good annuity provider, you could be pleasantly surprised at just how much income you could benefit from. You are allowed to take up to a quarter of your pension fund as a tax-free lump sum and put this straight into a pension annuity. You can then usually convert your entire remaining pension fund into an annuity for retirement before your 75th birthday. Find below some of the cheapest and best resources available on online annuity quotes, fixed annuity quotes, variable annuity quotes, immediate annuity quotes, deferred annuity quotes and other annuity quotes. Please explore various options and get multiple annuity quotes by providing your details and satisfy yourself before you buy.
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What is Annuity?
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.
There are generally three types of annuities — fixed, indexed, and variable. 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.
In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected. Variable annuities are securities regulated by the SEC. An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the SEC. Fixed annuities are not securities and are not regulated by the SEC.
Annuities: What You Need to Know
Annuities are a basic staple of modern portfolios, the financial equivalent of a backstop to guarantee a minimum of income in retirement. They work like an old-time corporate pension plan, paying out a regular amount of money over the course of retirement. The big difference is that amount you receive is wholly dependent on how much you put into the annuity.
Here are the basics of annuities.
TYPES In its most basic form, an annuity is a contract with an insurance company that makes payments at regular intervals for a set period of time. The classic fixed-annuity provided people a set payment for however long they lived — from a few months to decades. An insurance company’s actuaries took their best guess on your life expectancy while you hoped to outwit them and collect a check into your 90s.
Few annuities are structured this way anymore. One reason is people have realized that a static payout is not great. For one thing, it does not account for inflation: $1,000 a month today will probably not buy as much in 10 or 20 years.
To make annuities more appealing — and to bring in more money — insurance companies created more sophisticated types of variable annuities. Many of these annuities offer the option of a higher payment if the value of the underlying securities rises yet lock in a minimum payment if they fall.
One popular annuity gives people a sense of flexibility by allowing them to withdraw some or, in certain cases, all the principal, if they need it. In living longer, people will require income for more time but they are also increasing their chances of contracting catastrophic illnesses, from cancer to Alzheimer’s, that carry huge medical costs. The guarantee of regular payments is comforting. But the need for a lump sum at a particular time can sometimes be more practical. Other popular models are structured to continue after the original beneficiary’s death. A “joint-survivor” clause stipulates that if the husband dies first, the annuity continues to pay out to his wife through her lifetime, while another provision leaves some of the remaining principal to other heirs.
IMMEDIATE VERSUS DEFERRED These are two terms that are often used when discussing annuities. The difference is simple but often obscures the vast array of annuities being offered. With an immediate annuity, a person pays a lump sum and begins receiving income right away. That’s the immediate part. In the past, these were usually life-only annuities, meaning if you died a week later, that money was gone. Now, immediate annuities have all the variations mentioned above.
A deferred annuity has two phases — accumulation and distribution. Over a period of time, a person builds up the value of the annuity and then selects a time to start receiving payments from it. People who change jobs, for example, could opt to roll their Individual Retirement Accounts into an annuity and let the money grow there. Or they could make contributions to the annuity for a set period of time as they would with any savings plan. When they have accumulated enough to finance their goals, they can decide when they want to start receiving payments. They can start and stop the payments at will, though the idea is that they will wait until retirement.
ALLOCATION TO ANNUITIES Regardless of what type of annuity you select, the main question is how much of your portfolio should you put into one? The rule of thumb is to use annuities to cover your basic living expenses. Most providers recommend that you put no more than a third of your assets in annuities. Others limit retirees to 75 percent. Financial advisers not associated with insurance companies will generally argue for putting little in annuities: they feel they can get better returns through a diversified portfolio of securities. That’s a harder sell, though, after two rounds of huge losses in the stock market in one decade.
BENEFITS AND LIMITATIONS The benefit of putting a chunk of your nest egg into annuities is the guaranteed payment. Whether the economy is good or bad, an annuity pays a minimum amount of income every month. You may have to put a large part of your nest egg into the annuity to receive the amount you need to live on, but you know it will be there.
There are four main downsides to annuities. First, they are expensive. A fixed annuity typically pays out no more than 5 percent of the principal each year. That means you would have to put $100,000 into a fixed annuity to receive an annual payout of $5,000. Even the most frugal retirees would struggle to live on $400 a month. To receive, say, $2,000 a month, they would have to invest $500,000.
The other cost is the fees associated with the annuities. One rule of thumb is the more guaranteed features attached to an annuity — from inflation adjustment to joint survivor — the higher the cost. These costs, as with , are embedded in the annuity itself. They do not come in an upfront fee but are hidden in the payouts.
A third problem is expectations. People who bought annuities with payments that grew as the underlying securities grew could be in trouble. Those payouts are not going up when the stock market loses 40 percent of its value in one year. Likewise, when government policy makers are more worried about deflation than inflation, payments that adjust for the cost of living are going to remain at the guaranteed minimum.
Lastly, the government taxes distributions from annuities as ordinary income, with rates that run up to 35 percent. Money put into a brokerage account is taxed at the capital gains rate, currently 15 percent. Under the current tax regime, if someone receives a payout greater than $32,500 a year, that would be taxed at a 25 percent income tax rate — higher than if that same amount had been paid out through a brokerage account.
The popularity of annuities waxes and wanes with the economic cycle. They had a resurgence in the years after the technology bubble burst in 2001 and 2002. The recession of 2008 could do the same, though insurance companies may be constrained: in response to previous demand, they underwrote so many annuities that credit rating agencies are questioning their risk management skills.
Like any part of a portfolio, annuities are best taken in moderation. They are a great way to guarantee a certain amount of fixed income in retirement. But if overdone, they could rob a portfolio of needed flexibility.
Source: NY Times