What is an Annuity?
An annuity is a payment that comes at designated intervals for a specified period of time. There are several different ways to end up receiving payments from an annuity.
An annuity can be considered a glorified savings account with a rate of return that on average will supersede any savings account you would have at a bank or credit union. Unlike the savings account or a CD you may have though a bank, an annuity grows tax-deferred & eliminates having to file a 1099 every year. The most common types of annuities are those sold by insurance companies, and these can come in several varieties. Other common ways to receive an annuity are through receiving pension benefits from an employer, being awarded a structured settlement from a lawsuit, and winning the lottery. Annuities offer a steady stream of income, and the purchase of an annuity is a popular investment to secure retirement income. You can now add riders to Annuities to assist with income protection, inflation protection, Long-Term-Care assistance & Death Benefit.
During your working years, you can use an annuity to accumulate assets. The money inside the annuity grows tax deferred. That means as long as money is inside the annuity, you don’t pay any federal income taxes on the growth! This allows your money to grow at a faster pace than it would outside of a tax-deferred instrument. You can invest your money in a deferred annuity in a single lump sum (called a single premium) or over a period of years (called a flexible premium).
An annuity can also provide you an income stream.
In essence, it's a paycheck, when you need it. However, because there are so many different types of annuities, each with their own set of rules and regulations, it is important to educate yourself on investing in an annuity, or selling an annuity you already own. Whether you use a deferred or an immediate income annuity to create an income stream depends upon how soon you want to start receiving the income payments. As their names imply, you can either begin receiving payments immediately or you may defer them.
Immediate versus Deferred Annuities
An Immediate annuity is basically an insurance policy that guarantees the policyholder will receive a series of payments. The term immediate refers to the fact that once the contract is established, payments will begin almost immediately. This is in contrast to a deferred annuity, in which payments do not begin until a pre-established date. Immediate and deferred annuities serve slightly different functions. Basically, with a deferred annuity, there is a set amount of time in which your investment is allowed to grow before you begin to receive payments.
Qualified versus non-Qualified
To understand the intricacies of some of the advantages of Annuities, we need to make a distinction between qualified and non-qualified annuities. When people refer to different investments they will commonly refer to the funds as non-qualified or qualified. These terms relate to whether or not the funds used to pay the premium have income taxes taken out. With a retirement plan/IRA, employers deduct an allowable portion of pre-tax wages from the employees, and the contributions and earnings then grow tax-deferred until withdrawal. This would be a Qualified plan. Non-Qualified plans are those that are not eligible for tax-deferral benefits. As a consequence, deducted contributions for non-qualified plans are taxed when income is recognized.
Here is a brief overview of the different types of annuities:
Fixed Indexed Annuities/FIA
An indexed annuity is a fixed annuity with an interest rate that is linked to the performance of a financial index, such as the Standard & Poor’s 500 Index. Interest is calculated based in part on changes in the index and credited on a regular basis. Like other indexed annuities, Fixed indexed annuities also guarantee a minimum interest rate. The driving force behind the majority of Annuity sales today are from the riders that can be added. (Please contact Sell My Annuity for a more detailed explanation of these riders.)
Fixed Annuity/Multi-Year Guarantee
This type of annuity offers the client a specific interest rate for a specified amount of time.
The insurance company immediately begins payments for life or for a specified amount of time in exchange for your contribution. Regular payments can be received on a monthly, quarterly, semiannual or annual basis. A portion of each payment represents taxable interest, and the other portion is a tax-free return of your initial investment.
Deferred Income Annuity/DIA
A deferred income annuity, or DIA, is a newer type of annuity that is essentially a cross between a single premium immediate annuity and a single premium deferred annuity.
These are are High Risk annuity contracts purchased for accumulation and allow the owner to save tax-deferred over a period of time and can be variable or fixed. Variable annuities allow the owner to choose where the cash value of the contract is invested. Clients can choose from a selection of separate variable investment options, and unlike fixed contracts, the insurance company does not guarantee the value of these investment options. IN A VARIABLE contract your initial investment is NOT protected.