The Most Frequently Asked Questions About Annuities
- Q: What is a tax-deferred annuity?
A: A tax-deferred annuity is designed to accumulate money so that the owner may be able to supplement their retirement by electing periodic income through annuitization, or systematic or partial withdrawals. It is a product issued by an insurance company where long term financial needs can be solved better than with some other financial alternatives. - Q: What are the major advantages with annuities?
A: Interest (earnings) accumulates tax deferred until earnings are withdrawn, the choice of a guaranteed stream of income for as long as the annuitant lives, and probate advantages are some of the advantages. Plus, there are the advantages based upon the type of annuity that you select like the ability to receive a guaranteed interest rate (Traditional Fixed), or the potential of a percentage of index gains (FIA) or the potential to balance risk and reward based on the investment portfolios chosen by the annuity owner (Variable Annuity). In essence, an annuity can help the customer build a substantial fund for their retirement and can give them an income they cannot outlive. - Q: Is the fixed annuity a secure alternative?
A: Yes, with fixed annuities, their annuity value is backed by the general assets of the insurer that issues the annuity. Annuities are not insured by the FDIC or any other government agency like Certificates of Deposit are. In the opinion of many, the money inside of a fixed annuity is as secure as the insurance company standing upon the guarantees - Q: Who prefers a traditional tax-deferred fixed annuity?
A: Consumers who want to accumulate more money for retirement and need a guaranteed interest rate but who have either a low tolerance of risk or too much money already at risk invested elsewhere. Customers who would prefer to make one single premium like with a single premium deferred annuity and customers who would prefer to make a premium on a regular basis or whenever they wish with a flexible premium annuity. - Q: Who prefers a Fixed-Indexed Annuity?
A: Unlike the traditional fixed annuity where the interest rate is determined by the insurer, the Fixed-Indexed Annuity is determined by an index like S&P 500 or The DOW and by other annuity contractual provisions like the participation rate. These contractual provisions plus comparisons plus more information about the Fixed-Indexed Annuity are discussed in detail later. However, the consumers who prefer the Fixed-Indexed Annuity are those who want to know how their earnings will be credited and/or who want a percentage of the index gains but none of the losses. - Q: Who prefers an immediate annuity?
A: Consumers who need a guaranteed income for either a certain period of years or guaranteed income for as long as they live and or their surviving spouse. - Q: Who prefers a variable annuity?
A: Consumers who want to accumulate more money at retirement and are willing to receive the potential risk of receiving less than the original cost when redeemed in order to achieve potential rewards. - Q: Who is the average non-qualified annuity purchaser?
A: Average age is 65 and in the middle tax bracket and they do not need all of their earnings now. - Q: What kind of dollars are going into the fixed annuity?
A: Maturing CDs, passbook savings, money markets, and Treasury bills. - Q: What kind of dollars are going into the variable annuity?
A: Dollars previously earmarked for stocks, bonds, and mutual funds. - Q: Is the annuity for everyone?
A: No. Dollars earmarked for short-term needs should not go into the annuity. In addition, at least 6 months income should be kept outside of the annuity. And, lastly, those who need current income should not consider the deferred annuity as their primary vehicle. On the other hand, those looking for one way “to potentially accumulate” more dollars on a tax advantaged basis might find the annuity extremely beneficial. - Q: Does the IRS impose a ceiling on how much can go into a tax-deferred annuity?
A: No, the government imposes no ceiling nor does an individual need earned income to qualify for the annuity. However, since the tax-deferred annuity is designed as a retirement supplement, the government does impose a 10% excise tax penalty on "pre-tax dollars" withdrawn or distributed before age 59.5 - Q: Since a withdrawal of principal is tax-free and IRS penalty free, can principal be withdrawn first and then earnings?
A: No, the government considers interest earnings coming out first. Naturally, any portion of a withdrawal exceeding earnings would be a tax-free return on principal. - Q: What if the fixed annuity is paying an interest rate less than other financial alternatives?
A: You should first compare the security of the annuity to the other alternatives you are considering. You then must remember that the earnings on the alternative that you are considering may be taxable every year whereas the earnings with the annuity are tax-deferred. On the other hand, if you are considering another annuity as an alternative, then Section 1035(a) of Internal Revenue Code allows annuity owners to transfer their dollars from one annuity to another annuity income tax-free if the exchange is done correctly (discussed later) - Q: What if the fixed annuity is performing less than most other variable annuities?
A: Again, Section 1035(a) is an option. - Q: How is the interest rate declared after the initial guarantee period (1 year or 3 years) for the Traditional Fixed Annuity?
A: Current market conditions, the insurance company’s portfolio, and the discretion of the insurance company will dictate renewal rates. - Q: How will customers know their annuity balance?
A: The insurance company will provide a statement of annuity value at least once a year. - Q: When does the annuity mature?
A: Although an annuity is similar to many secure taxable alternatives in many respects, many annuities do not mature like CDs after the initial interest rate guarantee period or after a period of years. Earnings continue to accumulate on principal until the annuity is surrendered or when a settlement option is elected or at the maturity age of 85 or greater. - Q: Will the annuity be tied up in probate proceedings?
A: If you list a "named" beneficiary, other than your estate, annuity dollars can avoid the delay and expense of probate. - Q: Will the beneficiary be taxed on the earnings that have accumulated inside the annuity?
A: Yes, beneficiaries will be taxed on the tax-deferred interest when they receive those dollars. However, if a beneficiary is the spouse of the owner and the owner dies, he/she may elect to continue the annuity and postpone taxes if the owner dies. If the beneficiary is not the spouse and the owner dies, then dollars must be totally withdrawn within five years of the owner’s death or they may be received over the beneficiary's life expectancy with payments beginning no later than December 31st of the year following the year of death. - Q: Is the non-qualified identical to an IRA?
A: No, while the non-qualified annuity has many of the same advantages as an IRA like a) tax deferred accumulation b) a 10% federal excise tax penalty for withdrawals and or distributions made prior to age 59.5, the premiums that go into a non-qualified annuity are never tax deductible. One could say that the added advantages of the non-qualified annuity could be a) that there is no government imposed maximum premium to how much premium can go into a non-qualified annuity plus b) you are NOT forced to begin distributions at age 70.5 like you are with an IRA. Some have said that a non-qualified annuity can pick up where an IRA leaves off. - Q: What is the difference between a single premium and a flexible premium annuity?
A: A single premium fixed or variable annuity will allow one premium being made. Insurers do differ but minimum premiums tend to be $2,000 for qualified money and $5,000 for non-qualified money. The maximum premium can range from $250,000 to $1,000,000 with some insurers permitting more if they know more about the specific case and they feel comfortable. On the other hand, flexible premium annuities allow for premiums to be made periodically. In general, the flexible premium annuity can be very helpful to consumers who want to make regular contributions to, for example, their IRA or to their TSA, (403(b) annuities). The flexible premium annuity is also helpful to the younger consumer who may not have a great deal of money for the single premium annuity but is still concerned about starting a retirement plan sooner instead of later.
