Types of Annuities

by Rob Phillips, CPA

The Fixed Annuity

A fixed annuity is an interest-based vehicle analogous to a bank-originated CD but directed toward retirement reserves. Typically, a lump-sum of cash locks in a 3-10% interest rate for 3-15 years. Their chief inconvenience — penalty fees from the IRS and the insurance company — is an important aspect only with premature withdrawal.

Fixed Annuity Advantages

  • Low risk
  • More liquidity than CDs
  • Tax-deferred
  • Characteristically greater returns than bonds, CDs, treasuries, or money market accounts

Fixed Annuity Drawbacks

  • Income withdrawals prior to the age of 59.5 are charged a 10% tax penalty by the IRS.
  • Growth remains tax-deferred, however eventually revenue is taxed at ordinary income tax rates.
  • The insurance corporation normally enforces a penalty if withdrawing above the yearly allotment.
  • Future monies cannot be combined with the same annuity agreement (but added contracts can be obtained).

The Indexed Annuity

An equity-index annuity (or fixed indexed annuity) is a class of tax-deferred annuity whose credited interest is linked to an equity index, characteristically the S&P 500. It assures a minimum interest rate (normally between 1% and 3%) and can share in a part of market increase.

Indexed Annuity Advantages

  • Income connected to the market
  • Minimum locked-in rate
  • Little risk
  • Available for short, medium, or long term (1-10 years)
  • Tax deferral
  • Limitless contributions
  • Life insurance (optional)
  • Yearly tax-exempt gifts of up to $13,000 for each party

Indexed Annuity Disadvantages

  • Taking out earnings earlier than the age of 59.5 results in a 10% IRS tax penalty.
  • Though tax-deferred initially, income is eventually taxed at ordinary rates.
  • Certain index annuities charge a 1-3% annual management payment.
  • Withdrawals surpassing the annual allowance sustain an insurance firm penalty.
  • Incomes shrink when withdrawn prematurely.

The Variable Annuity

A variable annuity is similar to a 401 (k) — you choose the make-up of your portfolio. The premium can be separated into subaccounts and invested into market segments of varying risk.

Variable Annuity Advantages

  • Safe foundation of assets for your heirs
  • Tax-deferred growth
  • Principal and interest certain
  • Avoidance of probate for your heirs
  • Increased death benefit
  • Market-linked returns minus the downside risk

 Variable Annuity Disadvantages

  • Income withdrawals prior to the age of 59.5 are levied a 10% tax penalty by the IRS.
  • Growth is tax-deferred, but eventually income is taxed at ordinary income tax rates.
  • Unlike fixed-rate instruments, variable annuities can lessen in value.
  • The insurance corporation normally enforces a penalty if withdrawing above the annual allowance.
  • Some variable annuities incur a 1-3% yearly management fee.
  • A $ 25-35 yearly fee disbursed to the insurance company to cover managerial expenses.

The Fixed Annuity “Resale”

Fixed-annuity resales are fixed annuities marketed by individuals. (Characteristically, a resold annuity is a lottery winner’s annuity disbursement, a lawsuit or structured settlement, or even a conventionally obtained fixed annuity.) For whatever purpose, the original holder of the annuity decides to give up the annuity in exchange for funds immediately.

To attract a purchaser for his fixed annuity, the holder needs to discount the annuity. For instance, say the primary owner is receiving a 4% fixed gain on his annuity. Through offering the annuity at a considerable discount, he establishes an opportunity for a purchaser to get a far higher return rate– generally approximately between 6% and 9%.

Fixed annuities have been some of the securest investments on record. Babe Ruth deposited a huge chunk of his capital in fixed annuities before the 1929 Stock Market Crash. Thanks to those annuities, he retired comfortably in the middle of the Depression.

Fixed Annuity Resale Advantages

  • Better-thannormal earnings
  • Annuity value unaltered by deviations in interest rates
  • The buyer is covered by both the claims-paying capacity of the life insurance firm and by state legal reserve pools

Fixed Annuity Resale Drawbacks

  • Typical holding period is 5 to 15 years.
  • Subject to interest-rate risk, comparable to all investments.

Issues to Contemplate

  • Make sure the annuity is from a leading insurance corporation with a positive evaluation from AM Best or other evaluation bureaus.
  • Utilize a bank trust corporation to ensure a safe transaction.
  • Make certain that you receive a closing book and that a lawyer reviews all the documents to safeguard you.
  • If the annuity is life-contingent, be sure that the financial organization incorporates a term life plan on the seller and that you are the beneficiary. This suggests that if the seller of the annuity dies, you get all the payments from the annuity and the proceeds of the term-life policy.

The Pension “Resale” — an Annuity Alternative

Comparable to annuity resales, pension resales are pensions offered by individuals. Again, the procedure requires that a term life insurance policy be written on the seller with the purchaser as the beneficiary.

The pension purchase entails a closing book and a lawyer. A bank trust company typically manages the transaction. The pensions are ordinarily from large concerns, the federal government, the military, and a few other institutions. State and municipal pensions are not sold as they are not deemed safe.

Pension resales are generally especially dependable. The pensions are supported via the Pension Benefit Guaranty Corporation, a federal agency.

Pension Resale Benefits

  • Usually 7 to 9% earnings — better than CDs or other fixed investments
  • No variations in value
  • Backed by term-life plans to protect the purchaser. If the seller dies, the purchaser acquires all the payments plus the initial investment returned.

Pension Resale Disadvantages

  • Not liquid
  • Extended wait time (for illustration, 10 years) for the purchaser to receive all the payments.
  • The purchaser can sell it at a later date but would be subject to a discount on the trade.
  • Interest-rate risk. If rates move up, the flat rate might not keep up with higher interest rates.

Items to Examine

  • Avoid pensions from states, cities, and smaller or stressed enterprises.
  • Look for pension resales that are from Federal government pensions, military pensions and major corporation pensions with a solid monetary situation.
  • Be certain an attorney is used for the closing and that the pension resale is administered via a bank trust company.
  • Make certain there is a term life policy that appoints the purchaser the beneficiary.

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