Fixed Annuity Basics

Looking for a safe way to grow money that will be used in retirement?  Fixed annuities are a solid choice!  An annuity allows you to contribute and accumulate funds to supplement your retirement income.  You pay a “premium” (often a single sum) to the insurance company.  The insurer invests the money and provides you with competitive interest rate that is guaranteed for a set period of time.  These rates are usually higher than the rates offered by bank CDs.  There are usually two phases to an annuity that is referred to as a “deferred” annuity.  The first one is the “accumulation phase,” where you grow money in a safe way in preparation for retirement.  Your funds grow tax-deferred until such time you decide to receive distributions. The second phase is the “distribution phase,” where you begin to take money out of the annuity for living expenses in retirement.

You can also skip right to the distribution phase by buying what is called an “immediate” annuity.  People already in retirement sometimes will make this choice because it guarantees a certain amount of money each month for a period of time that the owner chooses.  With an immediate annuity, you pay a lump sum into the contract and “annuitize” it right away so the monthly payouts can be made to you immediately (often as early as 30 days later). Any interest gains on an annuity are taxed as ordinary income to the owner when the money is received during owner’s life or to the beneficiary after the owner’s death.

• Tax-deferral -- You pay no taxes on interest earned until you withdraw the funds, which means faster growth. To clearly see this advantage, compare this with a CD or a money market account, where you pay taxes annually on interest earnings. Although the gains on annuities will eventually be taxed, this delay will allow your money to grow to a higher amount.
• Ability to set up monthly income for life! (or any other specific period of time (see below)

When you are ready to “annuitize,” and receive distributions, you may choose one of the following pay-out options:

Life only (Straight Life) – you (‘the annuitant”) receive a specific amount for the remainder of your life, but cannot identify a beneficiary to continue to receive the money after you die, so the payments stop when you (the annuitant) die. While the annuity payments are guaranteed for your lifetime, there is no guarantee that all the proceeds will be fully paid out. Because of these restrictions, this choice provides the highest monthly payout.

Life with “Period Certain” – you receive a specific amount for the remainder of your life, and if you die during a “certain” period of your choosing (such as 10 or 20 years), the payments will continue to be paid a beneficiary for the remainder of that time.  If you die after the “certain” period, nothing will be paid to the beneficiary.

Life with Guaranteed Minimum (Refund Life) - if you die before the principal amount (your original investment in the contract) has been paid out; the remainder of this amount will be refunded to your beneficiary. There are two types of “refund” life annuities:

• Cash Refund - your beneficiary receives a lump-sum refund of the principal minus payments already made to you.
• Installment Refund - The beneficiary will continue to receive guaranteed installments until the entire principal amount has been paid out.

Joint Life - is a payout arrangement where two or more annuitants receive guaranteed payments which are made to them jointly until one person dies, at which time the payments will stop.

Joint Life and Survivor - is a payout arrangement where two or more annuitants receive guaranteed payments which are made to them jointly. After the first annuitant dies, the survivor will continue to receive payments for the remainder of his or her life. The survivor’s payments will be 100%, 2/3 or 1/2 of the pre-death payment and the choice will have an impact on the original amount of the payments.

Fixed Period - with fixed period installments, you select the time period for the benefits, and you are paid a specified amount for a period of time of your choosing. If you die before all the funds are disbursed, your beneficiary will receive the balance.

Fixed Amount – with fixed amount installments, you select how much each payment will be, and the insurance company determines how long the benefits will be paid by analyzing the value of the account and future earnings. This option pays a specific amount until funds are exhausted. If you die before all the funds are disbursed, a named beneficiary will receive the balance.

Although annuities allow for withdrawals, you need to be aware of possible tax consequences and other possible penalties. You should review your contract and consult federal tax rules before taking any withdrawals. Annuities typically have two types of penalties, Internal Revenue Service (IRS) and insurance company.

Insurance companies also impose surrender charges (in excess of allowable free withdrawals, usually 10% annually) to their annuities, which typically run from 5 to 10 years. If you withdraw money from your annuity contracts during the surrender charge period, in excess of the free withdrawals, a surrender charge will apply to the withdrawn amount.

If the owner dies and the annuity has not been annuitized, the entire annuity value will be paid to a named beneficiary or to the owner’s estate if there is no beneficiary or the beneficiary is deceased.  If the annuitant dies after the annuity has been annuitized, the annuity money may be disbursed to a named beneficiary according to the payout option elected.

Unlike qualified plans such as IRA and 401(k) that are subject to contribution limits set by the Regulation, annuity limits are set by the offering insurance companies, often at high limits. As an example, you can contribute up to a maximum of $500,000 per annuitant to Vantis Life Freedom series annuities.

Annuities are generally funded with after-tax dollars, meaning only the interest earned is taxable. However, annuities are taxed on a last-in, first-out (LIFO) basis, which means the money that comes out initially is attributed to the earnings portion of your annuity. Therefore, all withdrawals to the extent that they have not exhausted the interest earnings will be taxed as ordinary income. Once the value of your annuity falls below the total premiums you have contributed to your account, additional withdrawals will not be taxed.

Annuities have two phases, an accumulation period and an income or payment phase. During the accumulation period, the premiums you contribute to your annuity grow tax-deferred. But if you begin withdrawing from your annuity, either during the accumulation period, or after you annuitize the contact and begin receiving income, you are required to pay taxes. If the annuity is non-qualified and funded with your after-tax dollars, only the interest portion is taxable. If it is a qualified annuity, all withdrawals or payments are taxed.

To discourage individuals from withdrawing funds too early, insurance companies attach surrender periods to their annuity contracts. Surrender periods are typically run between 5 to 10 years or longer. Should the annuity owners withdraw money in excess of yearly allowable amount (usually 10%), during the surrender period, they will pay an early surrender penalty.

Fixed annuities are among the safest types of investments, and the risk of loss is low. Fixed annuities are generally structured to minimize risk with conservative, fixed rate returns. Furthermore, many contracts offer a Principal Guarantee or Return of Premium rider, guaranteeing the owner an amount no less than the total premiums paid (minus any withdrawal, applicable premium taxes and processing fees) when the contract is surrendered.

Most annuities are non-qualified which means, they are funded with owners’ after-tax monies. A great advantage of a fixed annuity is that contributions grow tax-deferred resulting in higher accumulations in the contract. At some point, however, taxes must be paid on the gain portion of an annuity. Taxes are due and must be paid by the owner at the time of surrender or when any withdrawals are made. By the same token, when a beneficiary inherits an annuity, he or she must pay taxes on the gain portion as ordinary income. Annuities are also included in the decedent’s estate for federal estate tax calculations.