Annuity

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At one time when an individual reached the age of 100 it was a cause for wonder and recognition, but not so any more. It is estimated that by the year 2050 more than one million Americans will be age 100 or older.† Many senior investors are concerned with living longer than their funds and becoming dependent on others. There is also the ever-increasing concern that there is the need to stretch retirement assets and provide funds to pay for larger healthcare bills.† For these and other reasons, many people in retirement avoid spending principal and attempt to live entirely on their investment income.† Therefore having a reliable, unending income stream is imperative to the well being and lifestyle of retirees.† This is where annuities come to the rescue.

 

††††† Annuities have been in Europe for hundreds of years.† Annuities have been in the United States for over 100 years.

 

An annuity An annuity is an investment that is made through an insurance company. It is a contract sold by the insurance company to an individual that provides income payments on specified dates to the individual or the designee of the individual in return for a premium or premiums paid to the insurance company. (Annuity policy owners can be individuals, partnerships, corporations or trusts). The most common types of annuities are fixed, indexed and variable.† Additionally they can be either deferred or immediate annuities. Any one of the three can be used as a Tax-sheltered Annuity.

 

Consider these things about annuities:

 

††††† Only an annuity can pay an income that is guaranteed to last as long as the† annuitant lives.† For this reason, annuities are often bought for future retirement income.

 

††††† Under federal law, annuities receive special tax treatment. Income tax on annuities is deferred, which means the investorís money grows tax-deferred as long as it is left in the annuity.

 

††††† Almost six percent of American households own an annuity; that is about one-third of the percentage of individuals earning at least $200,000 annually.Ļ

 

††††† Although there is some variation in buying ages depending on whether the annuity is a fixed annuity or variable annuity, approximately 30 percent of the owners of non-qualified annuities are age 72 and older.

 

††††† The purchasers of equity-indexed annuity contracts were about seven years younger, on average, than purchasers of declared-rate (fixed) annuities.

 

††††† The four reasons generally given for the majority of non-qualified annuity purchases:

1. †† provide a supplemental retirement income;

2. †† ensure funds are available, if needed, to purchase medical care;

3. †† guarantee an income to a family survivor; and

4.†† assure that funds are allocated to a safe financial vehicle in the event other investments perform poorly.

 

††††† Eight out of ten owners of an annuity that were interviewed identified three reasons that led to their purchasing an annuity:

†††† have an annuity income if the owner or spouse lived beyond his or her life expectancy

†††† avoid dependency; and

†††† ensure a retirement income.

 

The ability to assume risk varies from person-to-person and is primarily affected by the personís financial situation and time horizon. In other words, risk is generally more tolerable if:

you can replace any losses by earning more income, and

the need for your accumulated funds is far in the future.

 

An annuity consumer must be able to assume a certain level of risk and easily tolerate it. The complete absence of financial risk is probably impossible. By avoiding one type of risk, we usually assume risk of another type.

 

For example; some people live in fear of losing their invested funds. For that reason, they avoid any investment strategy that would put their principal at risk. Instead, they keep all of their funds in savings vehicles earning less than 1 percent, on average (in 2016).† Since the cost of living has been increasing at a rate faster than their after-tax earnings, they have not really avoided risk; they have simply traded market risk for inflation risk. They will not lose their principal to the unpredictability of the market but they will lose it paying higher prices for needed goods.

 

Risk adverse investors need to recognize that despite their low tolerance for risk, they must continue to invest a portion of their funds in some form of interest bearing instrument in order to counter the eroding effects of inflation.†† However, knowing how to control risk will help you tremendously. If it comes down to you having to buy an annuity because the annuity appears to be able to solve future income and inflation concerns, knowing all you can about the risks you may have to take is your first step to controlling the risk.† Performing risk control actions such as the following could help your annuity purchasing effort:

 

††††† You must understand the consequences of you actions and decisions;

††††† You must ensure that all of the material facts concerning the annuity being recommended to you is adequately disclosed to you by the agent;

††††† You must understand the language used to explain the annuity to you and the agentís explanation must be clear and unambiguous;

††††† You must ask questions concerning the annuity (no matter how silly you think they may be) and ensure that you receive appropriate, clear and meaningful answers

††††† You must NOT allow yourself to be talked into taking the agentís annuity recommendation if you feel it does not meet your needs. Insist on being given a reasonable period in which to change your mind if needed.

 

All annuities have two stages:

 

1.†††† The accumulation stage becomes effective immediately upon selection of the investment.  During this stage, the account grows cash tax-deferred.  

 

2.†††† The annuitization stage or payout stage goes into effect immediately upon the disbursement of payments from the annuity.  An annuity can make guaranteed  payments for a specific period of time, including life-time. Income Tax is paid on the interest earned, but not on the principal.

 

 

There are four parties to an annuity:

††††† Insurer (Insurance Company)

††††† Contract Owner

††††† Annuitant

††††† Beneficiary

 

The Insurer

The insurance company is the insurer.  The insurer contracts with the contract owner - the entity that purchased the annuity - to invest the contract owner's money and make the contract owner certain guarantees.  These guarantees, along with the terms and conditions of the annuity and the use of the annuity funds are detailed in the annuity contract.  

 

Contract Owner

The contract owner is the person or entity that bought the annuity.  The contract owner chooses the type of investments for the annuity from the available options, and has all rights to the following:

††††† Adding funds to the annuity

††††† Withdrawing  all or part of the funds of the annuity

††††† Changing the parties to the annuity contract

††††† Surrendering or terminating the contract

 

The contract owner can be one or more individuals of legal age, a minor if the policy lists the minor's custodian, a corporation, a trust or a partnership. The contract owner can also be the annuitant and the beneficiary.  In most annuities, the contract owner is also the annuitant, who is also an individual. The contract owner can dispose of the proceeds of the annuity in any legal way he/she/it chooses.  The contract owner can change the annuitant and the beneficiary at any time.

           

Annuitant

The annuitant is the person on whose life the contract is based.  The annuity contract remains in force until the annuitant dies or the contract owner terminates the contract. The annuitant must  be an individual and cannot be any other type of entity.  As a rule, the annuitant must be under age 75 on the date the contract is signed.  Most companies limit the annuitant's age at signing to between 70 and 80 years old.

 

The contract is also signed by the annuitant at the time of the annuity purchase.  But even though the annuitant signs the contract, the annuitant has no control over the annuity.  The contract owner has all control.

 

Beneficiary

The beneficiary of an annuity can be one or more individuals, or any legal entity.  More than one beneficiary can be specified in the annuity contract, and any combination of beneficiaries can be named.  The contract owner can change the beneficiary at any time to anyone or any legal entity.

 

Fixed Annuity

 

A fixed-rate annuity provides the contract owner with a fixed rate of interest on the money in the annuity for a specific period of time.  There is an initial interest rate which is usually guaranteed for a period of one year (12 months). The rate of interest credited to the annuity in the years following the initial rate, is called the renewal interest rate.  The renewal rate is not guaranteed because it is based upon the performance of the insurance company's own money in its investments.  Depending on the insurance company's investments performances, it can be greater or less than the initial rate. 

 

There is, however, a lifetime guaranteed rate commonly called the minimum interest rate.  The insurance company guarantees that the interest credited (paid) to the annuity contract in any given year will never fall below the minimum interest rate.  By all investment standards, the fixed-rate annuity has no equal.  Its interest rate is guaranteed every day.  

 

Fixed annuities usually have a money back guaranteeThe insurance company assumes the risk of investing, and the contract owner receives the protection.  The insurance company guarantees the contract owner that if he/she is unhappy with the annuity after 10, 20 or 30 days (depending on the insurance company) after purchasing the annuity, the contract owner may return the annuity to the insurance company and have all of his/her money returned to him/her.

 

Most fixed annuities have a surrender charge associated with them.  Surrender charge protects the insurance company in the same way the guarantee protects the contract owner.  Surrender charge can be as much as 3% to 16% of the annuity value.  However, it  is setup to decrease in amount from the 3% or 16% down to 0% over a period  of years as defined by the annuity contract.  Once the  0% is reached, the contract owner can surrender or terminate the annuity contract without incurring a surrender charge.  Many fixed annuities guarantee that the surrender charge will never dip into the principal. Fixed annuities  guarantee the contract owner the return of his/her/its principal. 

 

Some of today's competitive fixed annuities have no surrender charge or 1, 2 or 3 years surrender charge period to match the life of the annuity - a feature designed to compete with Certificate of Deposits (CD's) for the client's money.

 

Some fixed annuities have a bailout clause or escape clause. An insurance company may allow an annuity contract owner to surrender part or all of the annuity without incurring a surrender charge under certain circumstances.  For example; a contract may provide for the owner to surrender the annuity without penalty if the interest rate drops below a certain level, or if the owner becomes a patient in a nursing home, or if the owner is diagnosed with a terminal illness.

 

 

 

 

 

 

Fixed Annuity (coníd)

 

Fixed annuities have a  guaranteed death benefit.  When the annuitant dies, the annuity contracts guarantees the beneficiary the entire value of the annuity less any outstanding loans at the time of death.  Like banks, insurance companies must, by law,  have a reserve - i.e., they must set aside a certain amount of money to pay back the annuities if the company's assets are threatened.  This reserve along with the many guarantees a fixed-annuity offers, makes the fixed-annuity a very safe investment

 

 

Equity Indexed Annuity or Fixed Index Annuity (FIA)

 

An equity indexed annuity, more commonly called a Fixed Index Annuity (FIA) provides the contract owner with the option of earning money from the upward performance of the stock market while not experiencing any of its downside, and/or earning money from a  fixed rate of interest on the money in the annuity.  When the contract includes a fixed-rate of return for all or a part of the annuity, the equity index annuity has a lifetime guaranteed rate commonly called the minimum interest rate.  The insurance company guarantees that the interest credited to the fixed return portion of the annuity contract in any given year will never fall below the minimum interest rate.  A contract owner has the option to put money into any of the available indices and/or in the fixed funds of the annuity. 

 

Fixed index annuities exercise a series of crediting methods that allow the contract owner upside participation in the growth of a variety of well known and accepted market indices such as the S&P 500, the NASDAQ 100, the SP Midcap 400, etc.  There are monthly and/or annual caps - meaning - the contract can only earn up to a certain percentage of return either monthly or annually.  However, these caps are way above the returns a fixed-rate annuity would earn.  Monthly and/or annual gains are locked in so that if the market takes a downturn, the gains are not lost but remain fixed where they are.  In a down market, instead of losing earnings, the contract is just not credited with any gains.  Simply put, the contract earns money when the indices go up and lose none of the gains when the indices go down.

 

Like fixed annuities, fixed index annuities  usually have a money back guarantee.  The insurance company assumes the risk of investing, and the contract owner receives the protection.  The insurance company guarantees the contract owner that if he/she is unhappy with the annuity during the "free look" period after purchasing the annuity, the contract owner may return the annuity to the insurance company and have all of his/her money returned to him/her.

 

As with most annuities, fixed index annuities have a surrender charge associated with them.  Surrender charge protects the insurance company in the same way the guarantee protects the contract owner.  Surrender charge can be as much as 7% to 10% of the annuity value.  However, it  is setup to decrease in amount from the 7% or 10% down to 0% over a period  of years as defined by the insurance company.  Once the  0% is reached, the contract owner can surrender or terminate the annuity contract without incurring a surrender charge.

 

Some of today's competitive equity index annuities have no surrender charge or a short surrender charge period  ( 1 to 3 years) - a feature designed to compete with Certificate of Deposits (CD's) for the client's money.

 

Some fixed index annuities have a bailout clause or escape clause. An insurance company may allow an annuity contract owner to surrender part or all of the annuity without incurring a surrender charge under certain circumstances.  For example; a contract may provide for the owner to surrender the annuity without penalty if the interest rate drops below a certain level, or if the owner becomes a patient in a nursing home, or if the owner is diagnosed with a terminal illness.

 

Variable Annuity

 

A variable annuity is similar to a mutual fund in that they both have investments where the funds are held in an account separate from the insurance company's general account.  They are also similar to the traditional fixed annuity in that retirement payments can be made periodically to the annuitants over a specific period of time.  Variable annuities shift the investment risk from the insurance company to the contract owner.  If the stock market performs well, the contract owner is likely to realize investment growth  that could exceed what would be expected from a fixed annuity.  Conversely, if the market takes a downward turn, the contract owner could experience a severe decrease in the annuity value.

 

The contract owner has total control of his investment choices.  The insurance company plays no part in directing the investments of the variable annuity. The investments in the insurance company's general account is managed by the insurance company and allows the company to make fixed interest guarantees to the contract owner.  Variable annuities, on the other hand,  invest deferred annuity payments through  the insurance company's separate account because they are based on non-guaranteed equity investments such as common stocks.  The value of the variable annuity fluctuates with the movements of the stock market during both the accumulation and the annuitization phases, affecting the growth of the annuity as well as the income earned from it.

 

To keep the variable annuity in line with the fixed annuity's accumulation and annuitization concept,  the accumulation unit and the annuity unit, respectively, were created.  During the accumulation period, contributions made by the contract owner, minus expenses, are converted into accumulation units equal to the value of the amount of money spent buying the shares in the underlying stock investment divided by the total number of shares. During the payout or annuitization phase, the accumulation units are converted into annuity units and given a dollar value.

 

A variable annuity contains a guaranteed death benefit, which provides that when the annuitant dies, the beneficiary will receive:

 

††††† The greater of the principal, plus any accumulation, or

††††† The value of the account on the date of death.

 

However, associated with the death benefit is annual  mortality and expense fee, and an annual contract maintenance charge.  The mortality charge is used to pay for the guaranteed death benefit feature of the variable annuity, as well as commissions and other overhead.  The fee is frozen and will never change over the life of the contract, but it can be anywhere from 1.2% to 1.5% of the account balance. The maintenance fee ranges from $25 to $50 annually.

 

Every variable annuity has built-in features that minimize risk and increase return. They are:

 

Professional Money Management:  All variable annuities are managed by professional investment managers, who are well educated in their fields of expertise, are experienced, are backed by research, and who are dedicated to selecting the right investments to achieve the desired objectives of the annuity.

 

Separate Accounts:  The securities investments of a variable account are kept in accounts separate from the insurance general account, and are therefore not affected by the performance of the insurance company's own investments.

 

Diversification:  Investments are made in more than one portfolio. The risk is spread among many securities to reduce the possibility of losing a large amount of money from any stock.

 

Switching Privileges: Most variable annuities allow the contract owner to move money among investment portfolios without incurring penalties and charges as long as the switches do not take place too often.  This allows the contract owner to rebalance his portfolios to take advantage of high returns.

 

Guaranteed Death Benefit:  Provides that if  the annuitant dies during the accumulation phase, the beneficiary will receive the greater of the premium paid into the annuity less withdrawals, or the annuity's current value.

 

 

Bonus Annuities (5%, 7%, 10%, 12%, 15%)

 

Insurance companies are competing for your money, and will pay you handsomely to invest with them.  Some insurance companies are offering bonuses of 5%, 7%, 10%, 12%, or even 15% of the initial premium you put into either their fixed-rate or equity index annuity.  Some insurance companies even extend this offer to include any additional premium you put into the annuity in the 5 years following the initial premium.  The bonus is added to the premium at the time it is received by the insurance company, then the entire amount (premium + bonus) is credited with interest.

 

For example:  An initial premium of $100,000 that is given a 10% bonus ($10,000) will net your annuity $110,000 that is further credited with interest.  If the insurance company is paying 2% guaranteed interest on their fixed-annuity, you are guaranteed to earn $2,200 for the first year, and your fixed-annuity balance at the end of the year will be $112,200. $12,200 return for one year is a 12.2% gain.  If you take an equity index annuity that participates in the S&P 500 index, and the index goes up 8 points, you will earn $8,800 for the first year, and your fixed-annuity balance at the end of the year will be $118,800. $18,800 return for one year is a 18.8% gain. 

 

Please note: For these kinds of bonuses, the insurance company will require you to leave your money in the annuity for at least 7 years, depending on company.  However, you are guaranteed the return of your principal plus any bonus you were given.

 

 

College Funding Annuities

 

Parents and grandparents can utilize the college annuity to fund college education when they want to retain control of the funds even after the child is eligible for college. The advantages of investing in a college annuity are:

 

First, you will qualify for an income tax deduction immediately upon your donation (similar to a charitable gift annuity), and you will pay no income taxes on the interest earned from the accumulation of funds in the account

 

Second, you can contribute up to $11,000 per year. This is considered a gift. Youíll have to pay taxes on any gift, if the gift is more than $11,000. However, you can get around this by having more than one person contribute funds to the annuity, up to $11,000 each.

 

 

Private Annuities

 

Many high net worth and ultra-high net worth clients use Private Placement life insurance (PPLI) and annuities (PA) to defer or eliminate income tax on the growth of tax-inefficient investments.

 

Private annuities are generally used as part of estate planning and are similar to Private Placement Life Insurance (PPLI), except they have no pure insurance component. Income-producing assets and/or cash are put (sold) into a private annuity structure (e.g., LLC or other). By doing so, the donor can remove assets from his or her estate, thereby gaining certain gift or estate tax advantages, and the donor can get a stream of income from the annuity while alive.

 

It should be noted that the IRS tends to closely scrutinize private annuities. Consult with your accountant and tax attorney about private annuities.

TYPE OF ANNUITY

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