Annuity FAQ: What You Should Know
What is an annuity?
To put it simply, an annuity is a contract between an individual (called the annuity owner) and an insurance company for a guaranteed interest-bearing policy with guaranteed annuity income options.
What is a tax-deferred annuity?
It is a tax-advantaged product issued by an insurance company where long term financial needs can be solved better than with most other financial alternatives.
What is the major advantage of annuities?
All annuity dollars are able to accumulate interest completely tax deferred. This means an individual can delay taxation of growth until the money is needed and therefore earn triple interest — interest on the principal, interest on the interest and interest on the money that normally would be paid in taxes.
Who wants to own an annuity?
People who want a safe way to reduce taxes and people who want to decide when to pay taxes. People who want to preserve their retirement money in a safe place and still have good gains while avoiding loss.
Is an annuity safe?
Yes — with annuities, your principal is 100% safe and you are guaranteed to earn at least a minimum interest rate. This guaranteed safety is possible because each insurance company issuing annuities is supervised and regulated by each state’s insurance department; plus, they are backed by a Legal Reserve System and a Guaranty Fund.
Is the annuity for everyone?
No. Dollars earmarked for short-term needs should not go into the annuity. In addition, at least six months of income should be saved for emergencies outside of the annuity. Also, those who need current income should consider an immediate annuity, not a deferred annuity. On the other hand, those looking for one of the safest ways “to accumulate” dollars on a tax-advantaged basis will find the deferred annuity extremely beneficial.
Who should consider purchasing an annuity?
Anyone who wants a safe way to accumulate funds through triple compounding without paying current taxes n earnings should definitely consider purchasing an annuity.
Since a withdrawal of principal is tax-free and IRS penalty free, can principal be withdrawn first and then interest?
No, the IRS considers that interest earnings are withdrawn first. Naturally, any portion of a withdrawal exceeding interest earned would be a tax-free return on principal.
What kinds of dollars can be used to buy annuities?
Dollars from maturing CDs, money market funds, checking and savings accounts, mutual fund accounts, stocks and bond funds, IRA rollovers, etc. can all be used to purchase an annuity.
What if the annuity is paying an interest rate less than other financial alternatives?
You should first compare the value of the “no market risk” feature of the annuity to other alternatives you are considering. You then must remember that the interest on many alternatives is currently taxable every year. Also, Section 1035 of the Internal Revenue Code allows annuity owners to move their dollars from one annuity to another annuity income tax-free.
Will an annuity be tied up in probate proceedings?
No — as long as the owner designates a “named” beneficiary other than his or her estate, the beneficiary will receive the annuity dollars without the delay, expense and hassles of probate proceedings
Will the beneficiary be taxed on the interest that has accumulated inside the annuity?
Yes, beneficiaries will be taxed on the tax-deferred interest when they receive those dollars. However, if a beneficiary is the spouse of the owner and the owner dies, he/she may elect to continue the annuity and postpone taxes. Once again, the client decides when to pay income taxes. If the beneficiary is not the spouse and the owner dies, then dollars must be totally withdrawn within five years or they may be received over the beneficiary’s life expectancy. However, this latter option must be elected during the first 12 months following the owner’s death.
Is an annuity identical to an IRA? No. Although an annuity is often used as the funding vehicle for an IRA, many annuities are purchased with after-tax dollars that are not deductible. Also, with annuities, there are not government-imposed limits on how much an individual can contribute to an annuity.
For more, go to www.lyvfin.com to consult with a professional.