by Annuities Explained on July 15, 2010
Fixed equity index annuities have grown in popularity among retirees to the point where as many as 30% of all annuities sold are now indexed to a popular fund, index, or other investment product.
Index annuities are annuities based on the value of another investment product unlike most deferred annuities that are based on a specific rate. For stocks, the most common is the S&P 500 index. An annuity based on the value of the S&P 500 index will rise, but never fall with subsequent one-year changes in the value of the index.
Be advised, the way interest works in fixed equity indexed annuities is different than that of traditional annuities. The insurance company writing the note will buy a one year option in the specific index to be tracked. At the end of the one year term, if the index is up from a year ago, then the option is cashed out, and the proceeds are added to the value of the annuity. At that point the insurance company buys another option for the next year. However, if the index has dropped in the one year term, the option is left to expire and no interest is accrued for that year. You can see why these products are so popular as they offer upside with zero downside. Plus, like all annuities, the growth tax-deferred, so you can rack up profits before ever paying a single dime to Uncle Sam.
Before purchasing a fixed equity indexed annuity you’ll have to decide a total investment period as well as the number of years in which you would like to receive a payout. A popular choice is an annuity that allows for a decade of growth before receiving monthly distributions. For example, if you plan to retire at age 70, then you would purchase the annuity at 60 for regular monthly payments at age 70.
You can, however, withdraw your investment in one lump sum following the end of the growth period. For example, an investor who buys a $100,000 annuity at age 60, which then grows to $200,000 at the end of a 10 year growth period can cash out immediately for the full value of $200,000. Beware, some insurance companies carry heavy fees for cashing out, and you’ll also have to pay capital gains taxes immediately. Regardless, the option is always there to cash out.
Should you choose not to cash out before receiving your monthly payouts, your fixed equity indexed annuity will operate just like any other. You’ll receive monthly payouts that correspond with the size of your annuity investment.
Fixed equity indexed annuities are best used by those who have plenty of time before retirement. Since the returns are generally based on a stock index, you’ll want to have enough time to accrue profits before reaching retirement age. Consider the fixed equity indexed annuity as pre-planning a retirement. It’s like investing in an annuity to later buy an annuity. One thing is different, though, and that is that unlike simple brokerage investments that aren’t included in a retirement plan like a 401k or IRA, the annuity grows tax free.
by Annuities Explained on June 27, 2010
There are a variety of variable investment annuities. Imagine the whole annuity market as a type. In this article, we’ll slice it once, right down the middle, followed by other smaller types within the two largest categories.
The Two Largest Categories
There are two broad categories of variable investment annuities, deferred annuities and immediate annuities. Deferred variable annuities are those that can appreciate in value before payouts begin. Immediate variable investment annuities are annuities that begin payouts immediately after the contracts are signed.
Subsets of Deferred Annuities
There are two other types within the deferred annuity type. These are the periodic-payment deferred annuity and the single-premium deferred annuity.
Periodic-payment deferred annuities allow an investor to build up a position in an annuity over time by making a series of periodic payments. These are very much like your classic pension program where you invest a certain amount of money periodically and receive a fixed monthly payout upon reaching retirement age.
Single premium deferred annuities are one time deals in which you invest a certain amount and no more is added before reaching retirement age. Often, these are purchased near retirement age to allow some time for growth before regular monthly payments commence.
Both types of deferred annuities have an accumulation phase built in where capital can appreciate in value. Also, you’ll be able to decide before retirement how the payouts should continue upon your death, or whether you’d prefer survivors to receive a lump sum. Many investors like this feature, since they can prepare for retirement, as well as have ample cash to pay for funeral costs and other post-death expenses.
Immediate Annuities
Immediate variable investment annuities are quite simple when compared to deferred annuities. In an immediate investment annuity, the payout begins immediately after the contract is written. However, since they are variable, the payout can rise, but never fall, from year to year.
Immediate annuities are usually tied to the change in value of popular stock indexes, mutual funds, or a selection of each. The most common are the most simplistic, and often based on the S&P 500 index rather than other indexes like the Dow Jones Industrial Average or Nasdaq composite.
Benefits to each
Both immediate and deferred annuities grow tax free until withdrawals. Deferred annuities incur a tax burden as money is withdrawn, whereas immediate annuities incur a tax burden immediately and the total tax cost rises as the value of the principle increases.
Be advised that the IRS is very finicky when it comes to taxes on annuity income and capital appreciation. Money drawn from an annuity before the threshold age of 59 and ½ years old is subject to a 10% penalty from the IRS. Insurance companies, too, can have their own preset charges for early withdrawals starting as low as 6 percent and rising well into the low double digits.
Though at first glance annuities may appear to be complex instruments, they are perhaps the most simple of any financial product. You’ll find that after cracking the surface, what you have is a retirement plan that is simplistic, consistent, and malleable enough to fit any retirement portfolio.
