Understanding Different Annuities
Receiving A Paycheck For The Rest Of Your Life Sounds Great, Right? This isn’t a dream. It’s actually possible thanks to annuities.
Annuities are a form of life insurance. You pay a sum of money (called a single premium annuity, not to be confused with a SPIA). This can be either all at once or over a period of time (flexible premium annuity). In return, your money does not go down (only if you buy from one of our advisors), it only goes up (depending on the crediting option you choose). Also if you buy an income rider (you will pay a fee, should only be about 1%) you receive regular disbursements of that money until you’re no longer living.
A staggering 84% of Americans believe that this is a beneficial concept, yet only 14% have actually purchased an annuity themselves.
A primary reason for the hesitation: A lack of knowledge around annuity options and uncertainty around purchase procedures.
It’s important to understand that not all annuities are created equal before you sign on the dotted line.
Interested in learning more? Let’s dig in!
The Big Two: Deferred Annuities Versus Immediate Annuities
Our discussion on the different types of annuity must begin with the two major categories: deferred and immediate.
Put simply, deferred annuities are those that you don’t receive until a set time in the future. Essentially, you pay your premiums in full, then wait. Some you can add money to called a flexible premium. I like the flexible premium annuities because they allow you to make additional deposits and all of the money matures at the same time. Again this is only available when you buy through our network of advisors. We have removed 90% of the annuities on the market and only allow the top 6-8 insurance carriers to be sold. That said other insurance people or advisors will sell you anything just to make a commission, we make sure you don’t get screwed.
The obvious advantage to this type of annuity? The longer your money sits, the more it grows. In addition, the investment remains tax-free until you’re ready to pull it out, at which time it’s taxed at the ordinary income rate. Again any return you made in the annuity comes out first and you pay tax on that.
Are Deferred Annuities Beneficial?
This type of annuity is also beneficial in the sense that it works with almost every pocketbook and timeline. Got a large sum of money you’re ready to invest? Great, you can put it all on the table and pay your premium immediately, again up to $1,000,000 (and we do a few per month that are above this number). Rather wait and pay your premium off over time in regular intervals, flexible premiums? That works too. Most annuities start at $10,000 or $25,000.
Yet, while time is on your side in that regard, it might be against it in another. The main drawback to this type of annuity is that you have to wait to access it.
If you make withdrawals before you reach retirement age, you’ll not only pay the income tax on your earnings. You will also be subject to some pretty hefty early withdrawal penalties and surrender charges, some of which could be as high as 20% of your investment when you buy outside of our network. REMEMBER do NOT allow anyone to sell you an annuity that has a surrender charge that is over 9% MAX MAX 10% and the term should not exceed 9 years. Most should be 6-7-8 years.
The other type of annuity is an immediate one.
Contrary to deferred annuities, which have an accumulation period during which you must wait to receive your earnings, immediate annuities start paying out no more than one year after you’ve paid your premium.
While most people choose to invest in deferred annuities when they’re fairly far from retirement age, those closer to that magic number might want to invest in immediate annuities.
This way, they’ll be a shorter window of time between when they make their payment and when they begin receiving their money.
Another advantage to these types of annuity is that they can provide a useful tax break. Here’s the breakdown:
The payments you receive on an immediate annuity are divided into interest and principal.
While the interest is taxed as ordinary income, the principal on these types of annuity remains tax-free, because it is essentially a return on your initial investment. This is known as the exclusion ratio.
Yet, one of the main drawbacks to an immediate annuity? It expires when you do, so the window of time to access it might be narrow depending on when you choose to invest.
Once you’ve decided whether you want to invest in a deferred or immediate annuity, there’s one more step to take. Now you must decide if you want to invest in a Fixed (Traditional), Fixed Indexed (FIA) or Variable Deferred Annuity.
Fixed (Traditional): This type of annuity is essentially a savings account offered by your insurance agency. The agency will use its in-house portfolio to determine the rate at which your money will build interest during the accumulation period. Lock in your interest rate in order to guarantee yourself that rate. That’s the good news. Most fixed products are 3 years to 7 years. The sweet spot as of this post is 5 years.
That same lock-tight security applies to your payments on these types of annuity. The amount you receive is then set. It will not change over the course of your lifetime.
This type of annuity is one of the safest and is advisable for the more risk-averse population, generally those 60 and older.
Fixed Indexed (FIA)
While Fixed Traditional deferred annuities lock you in a certain interest rate, the interest provided under FIA (index annuity) annuities is based on how the stock market performs.
Consequently, your interest rate is determined not by an internal portfolio, but by the performance of an external index. One example is the S&P 500.
While the credited interest is subject to these external conditions, it may fluctuate during the accumulation period, but it will never fall below zero.
Interest rates are subject to market volatility. A company’s rate lock does not offer security. They could even go way below zero. It is like owning mutual funds. When the market drops 20% your variable annuity will fall even more then 20%.
Such conditions can be risky. Your insurance company will set a minimum payment amount at the onset to ensure that no matter how the market dips and surges, you’ll have a guaranteed payout at the end.
PLEASE REMEMBER the FEES on this type of annuity are 3-5% and have market risk. Most of our clients do not buy this unless they are in their 30’s max 40’s and have 20 years before they retire.
Making the Move: The Right Types of Annuity For You
Not sure if an annuity is right for you? Or maybe you’re sure you want to invest, but you don’t know where to start or who to talk to?
That’s why we’re here. We make it easy to pick the investment plan that best fits your budget, goals, and future dreams.