How does a fixed annuity work
Understanding "FIXED ANNUITIES"
What is a Fixed Annuity? Why would anyone want one? What are the features and benefits and drawbacks? Are they all the same? Which company would be the best? Which annuity might be best for you? Fixed annuities are widely used for many reasons. Why?
NOTE: Annuities are NOT used for their tax-deferred growth when combined with an IRA. There are many other reasons (as described here) for using an annuity, since an IRA already offers tax-deferred growth without the use of an annuity.The (2) main reasons are because they offer Safe, Guaranteed*, Competitive interest rates for growth and/or income and you pay NO income taxes on your gains until you take withdrawals.
- Safety of principal
- Competitive Rates
- Tax-Deferred accumulation
- NO up front costs-100% of your money goes to work immediately
- Access to your money - a surrender penalty may apply on excess early withdrawals
- Guaranteed* death benefits-payable outside of Probate
- Control of income and taxes (you determine when you take money out and therefore, when you want to pay the taxes on the gains). You're taxed at ordinary income tax rates rather than at capital gains tax rates.
- Opportunity to create an income you can't outlive for LIFE
- Can be used for ANY kind of money, including IRA's, 401k rollovers and much more.
- Note however that fixed rate investments, such as fixed annuities, over extended periods of time may not offer direct protection against the possibility of inflation. Neither Spivak Financial Group or Centaurus Financial Inc. offers legal advice. Please consult with a Tax Professional for your personal tax consequences.
Let's look at a hypothetical example to illustrate:
Jane, age 60, has $100,000 wants to keep safe, she wants it to grow at a reasonable rate and she doesn't want to pay any unnecessary income taxes. The fixed annuity may be an appropriate place to put her money. Jane first determines how long she wants her money to be in the annuity, that's why they offer a wide range of contracts ranging from as short as 1 year to as long as 16 years. The most common time-frames are 5-10 year annuity contracts. Let's say she can probably get by without using this money for 5 years (but just in case she needs it, she COULD get it out of the annuity if absolutely necessary. This will be explained in more depth later).
Jane might pick a 5 year annuity contract. In this example, let's assume the rate offered for the 5 year annuity is 3.5%. In MOST cases, the fixed rates offered by annuity companies are almost always higher than savings accounts or typical CD rates, that's often WHY people use them. NOTE: rates change and therefore this example may be not be correct at the time you read it. Always check with your Financial Advisor for up-to-date rates and terms.
At the end of the 5 years, Jane's $100,000 would have grown to $118,769 if she simply let the interest accumulate and compound within the annuity. She pays NO income taxes on that growth, as long as she doesn't take anything out of the annuity. (Withdrawal of earnings are always taxed as ordinary income, when withdrawn, but not until it is withdrawn, from an annuity.)
If Jane had her money in any other type of investment that required her to pay income taxes each year on her earnings, and she is in a 28% tax bracket, she would have only been able to accumulate $113,251 after income taxes. Therefore, having her money in the annuity and deferring the taxes on the earnings each year, by allowing it to accumulate in the annuity may be a definite advantage.
The above example illustrates why many people may be better off with their money in a quality fixed rate annuity instead of in CD's!
At the end of the 5 years she can pull her entire $118,769 out and walk away from the annuity. (Of course, she will be required to pay income taxes on her gains, the $18,769.) Frequently some uninformed people say that annuities cost too much, so don't use them.
This type of advice is absolutely WRONG! To prove the point.
Assume Jane wants an income stream from her $100,000. Again she puts $100,000 into the annuity and simply has the company send her a check every month, or quarter or each year for the interest earnings. Which using the same scenario as above with the 3.5% rate, she would receive a check each year for $3,500 (which of course is income taxable). At the end of the 5 years, she pulls her $100,000 out and walks away, if she likes. So where is the cost? She gets all the growth and gains! She receives a TRUE 3.5% on her money!
What are the advantages of a Fixed rate annuity over a CD? (DISCLOSURE NOTE: CD's are often FDIC insured, if purchased through most banks. Annuities are not FDIC insured.)
Fixed annuities are Safe, Secure, Dependable and easy to use. Most fixed annuities allow withdrawals of up to 10% per year without incurring any expense or penalties. They are designed this way to allow people to generate an income, if that is their desire. A few even offer higher withdrawal amounts up to as high as 15%, in some cases.
IF you exceed the withdrawal limits then there can be penalties. This is to discourage people from withdrawing all their money or taking out too much-too soon. Check with your Financial Advisor and make some comparisons to make sure you are getting what you want and need.
OWNER- ANNUITANT- BENEFICIARY: Every annuity has several components to it. Longer term annuity contracts, such as a 7 year or a 10 year annuity normally offer
higher Guaranteed* rates than shorter annuity contracts.
The owner is the person who originally puts the money into the annuity and controls it. They have the right to make changes to it, they own the money inside the annuity as well (and for estate planning purposes) it is also included in their taxable estate. The owner can be more than one person, and they don't always have to be related, such as husband and wife. Even a Trust, a son or daughter, or even a friend could be the owner.
The annuitant is the person who is supposed to get the money if it is paid out at the end of the contract, or as an income stream while the annuity contract is active. This CAN BE someone other than the owner (above). The annuitant can also be more than one person, in some cases. So it could be paid out to more than one person.
The beneficiary! Annuities are issued by insurance companies. Annuities are contracts and can be passed on to a named beneficiary and there can be more than one named beneficiary. Money paid to named beneficiaries are paid directly to them and therefore avoid Probate. This is another common reason why people often use annuities. They avoid Probate! Neither Spivak Financial Group or Centaurus Financial Inc. offers legal advice. Please consult with a Tax Professional for your personal tax consequences.
There is alot of flexibility and control by using annuities to pass assets onto loved ones, very effectively and outside of probate. Annuities can even name a Trust as the beneficiary for even greater control and added flexibility.
Do You Want a Lifetime of Income?
Annuities (Fixed, Indexed and Variable) are the only investment product that offers a person or couple, the opportunity to exchange their annuity for an INCOME for LIFE! An income you cannot outlive! "ANNUITIZATION"
There are some minor differences between companies and the various annuity contracts, but in general most offer a variety of "annuitization options ". In brief, an "annuitized " annuity can provide you with a several Income Options allowing for a guaranteed* income stream that will last either for YOUR LIFETIME, a JOINT LIFETIME (with you and another person) or for a specified FIXED time period. When you "annuitize " an annuity contract, in most cases, you are trading the assets in your annuity to an insurance company, who in turn will guarantee* to pay you AS AGREED (which in most cases is for LIFE) depending on what payout method you might choose.
For example: a person can get a LIFETIME Guaranteed* income with a minimum of 5 years certain, 10 years certain or even 20 years certain. This assures a person that even if they were to die prematurely, their heirs would receive what's left. There may be other annuitization options available, depending on the company and the annuity product chosen.
WHICH COMPANY? - WHICH ANNUITY? There are literally hundreds of companies and sales personnel that offer fixed annuities. Banks, your local car and home owners insurance agent, fraternities, brokers, accountants, etc. Fixed annuity sales people do NOT have to be securities licensed in order to sell FIXED annuities. ANYONE with a state issued life insurance license can (in most cases) sell a FIXED annuity. So make sure you work with someone knowledgeable and reputable.
A license to sell a FIXED annuity or a life insurance policy doesn't mean they know what they are doing. It also doesn't mean they represent a company with high rating or good reputation. There is alot to learn which takes years. We've simply scratched the surface on this subject in this brief article. (We know, you probably think it's going to go on forever. Right?)
The point is! Select a REAL Professional to assist you in choosing the RIGHT annuity for you. Also, choose a QUALITY company! It could make a difference. A BIG difference! We only use top tier rated companies for our clients to put their money with. WHY? The Guarantees* offered by the company you select are ONLY as good as the strength of that company and their ability to keep those promises and pay their annuity contract owners the money they owe them. Right? There are NO other Guarantees! Therefore, you want the strongest, most reputable company you can find to put your money with. We always try to use companies that maintain the highest ratings as Rated by: A.M. Best, Standard & Poor's and Duff & Phelps.
** Annuities offer tax deferred growth and are primarily designed for long term growth. If a person withdraws money from an annuity prior to age 59 1/2, they are subject to an "early withdrawal penalty" of an added 10% owed to the IRS. However . if a person under the age of 59 1/2 wants to make withdrawals, they can use, what is called, a 72(q) to establish an income stream from an annuity to avoid the additional 10% IRS penalty. For withdrawals of IRA money from an annuity, they can use this same method, it is called a 72(t). For information on how to do this GO HERE
NOTE: All Guarantees are based on the financial strength and claims paying ability of the company chosen for an annuity.
Our goal, as Financial Advisors is to provide our client's with information, products and services, that can help you achieve your goals and fulfill your needs, the best ways possible. Feel free to contact us for more information and the specific names of the companies referred to in this and other articles on our website. Neither Spivak Financial Group or Centaurus Financial Inc. offers legal advice. Please consult with a Tax Professional for your personal tax consequences.
The above information is NOT an offer to sell a product. Is it simply to provide information.Source: www.moneymanagment.info