What Is An Annuity?
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What is An Annuity?

An annuity is a savings account with a life insurance company. They are similar to a CD but there are some differences. They are often used either to save for a retirement income fund or as a means of retirement income distribution. There are other uses as well.

Sometimes people have already saved money but want to put it somewhere that is safe and have it distributed over time, perhaps over the duration of their life.

The name derives from the same root as the word annual. They have been around for more than 2,000 years. They've been used in the U.S. since before we were a country. The first annuity in America was issued in 1759 in Pennsylvania.

Some Ways they’re similar to a CD

• They are a long-term savings account based on a contract.

• There are terms of the contract. If the terms of the contract are violated, there are penalties.

• The most common penalty for both is for premature withdrawal.

Some Ways they’re different from a CD

• The financial earnings of an annuity are tax-deferred. Earnings from an annuity don’t need to be reported until money is withdrawn, unlike a CD which is taxable as earned and must be reported as income each year.

• Annuity contracts are usually longer, from 3-16 years, as opposed to a CD which can range from 30 days to 5 years.

• Annuities are issued by life insurance companies not banks

• Generally requires a minimum $5K to start unless used as an IRA

Different types of annuities

• Fixed—pays a guaranteed interest rate and there is no risk of losing money

• Fixed indexed—interest rate fluctuates based on an index that mirrors the performance of the stock market without actually being in the stock market. Gains have a cap but loss is protected.

• Variable—interest rate fluctuates with the performance of the stock market and there is no guarantee of not losing money because money is in the stock market.

• Deferred—money will be paid out at a later date.

• Immediate—money will be paid out beginning immediately

Stages

• Accumulation—the time when money is being put into an annuity

• Annuitized—the time when money is paid out, usually on annual basis (usually after age 59 ½)

Some Pay- Out Options

• Complete withdrawal upon maturity--contract will not be annuitized.

• Period certain-generally 5-20 years

• Lifetime—it’s a guaranteed lifetime income annuity if the guaranteed lifetime benefit rider (GLIR) is taken.

Fees

• In many cases there are no fees. Often length of time is the only fee

• Some companies charge management fees especially in variable annuities

• Some companies charge a small fee for the GLIR, usually about 60-80 cents per $100.

Some Special Provisions

• Partial withdrawals (generally 10% per year) are allowed without penalty

• Some companies offer bonuses on initial premium for certain contracts.

After Death

• Whatever money remaining in the contract is paid to a named beneficiary and it could be a taxable event.

• If no money remains, contract terminates at death

Some Common Usages

• Retirement Income

• Lifetime income

• 401k or IRA rollover

• Pension supplement or replacement

When considering annuities it needs to be understood, they are not for the short term. They are for the long term and it boils down to one key question: When will the money be needed?

If the answer to the question is less than 3 years, annuities are probably not a good option. On the other hand, if partial withdrawals are acceptable and waiting until the maturity date to withdraw the remainder, it may work.

If the answer to the question is the money may never be needed, won't be needed for at least 3 years, chances are good an annuity could be a good fit.

Taxation does not occur until money is taken out of an annuity (upon distribution or withdrawal). How it is taxed and the amount it is taxed is determined by a variety of factors at the time of distribution or withdrawal.

Annuities are subject to a surrender charge if a contract is canceled prior to its maturity or if the allowable partial withdrawal amount is exceeded. Generally, the surrender charge declines each year until maturity, which is when the surrender charge is eliminated.

There is a misconception that you can’t access fast money when it's in an annuity. Access is always an option but there are rules. If the rules are broken, there are penalties. Understanding the rules is key.


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