PERSONAL FINANCE annuities 1
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table of contents What You Should Know... 02 Annuity Basics... 06 Selecting An Annuity... 10 Buying An Annuity... 12 Resources... 16 1
what you should know 2
What is an annuity? Many hard-working Americans dream of their retirement carefree days filled with leisure activities, travel, and family time. But if your financial goals include maintaining your current standard of living in retirement, you want to take appropriate steps now. Annuities are useful financial investment tools specifically designed to help people achieve their retirement saving and income goals. An annuity is a contract between you and an insurance company. It can be part of a long-range retirement plan. It has three stages: start-up, accumulation and payout. When you purchase an annuity (start-up), you pay the insurance company an amount of money, either in a lump sum or series of payments. Your money has the potential to grow tax-deferred over time (accumulation). In the final stage (payout) you have options depending on how you want to receive the money in retirement. The options include a lump-sum payment or an income stream that cannot be outlived. What are the benefits of an annuity? This publication contains information to help explain: How annuities work. How to select the right annuity features. How to purchase an annuity. An annuity can provide something no other planning tool outside of Social Security or a pension can offer the potential for lifetime income. Annuities are designed to protect you from outliving your savings. When an annuity is owned by an individual, all earnings are tax deferred for current federal income taxes. In other words, earnings are taxed only when you take money out of the annuity. Over time, tax deferral, combined with the benefits of compounding, may help your money grow faster. And when you do withdraw the money, as a retiree, you may be paying a lower tax rate. Some people resist investing in annuities because they want more control over their money. But annuities actually offer a wide range of withdrawal and payment options, so you can tailor a plan to fit your needs. You may choose a lump-sum withdrawal which you can bank or reinvest or arrange for a series of periodic payments, which begin immediately or at some future date. 3
How does an annuity fit your retirement plan? PENSION $ 2500 SOCIAL SECURITY $ 2000 4 Planning for retirement can be daunting. If you re relatively young, it may not seem urgent. And if you are older, you may worry that financing your retirement will cost more than you imagined. Either way, it is never too early to start planning. And although there are many ways to plan for your retirement, experts suggest that a retiree s basic living expenses should be covered by a guaranteed source of income. Basic living expenses typically include items such as housing, transportation, food, insurance, and debt, and can be broadly defined as any essential expense which simply must be paid, regardless of the income produced by risk assets. Other guaranteed sources of income include social security income or a defined benefit from a pension. But if these aren t enough to cover your needs, guaranteed income from an annuity can fill the gap. Like many individuals living in times of economic uncertainty, you may be facing crucial investment decisions that will affect your future lifestyle. Your employer may be reducing or eliminating contributions to your retirement plan. Or you may have struck out on your own as an independent contractor. This means more individuals are responsible for supplementing their retirement income through careful planning, investing and money management. Even if you have substantial net worth, not all of your investments may generate income. For example, some stocks do not pay dividends. And even stocks that pay regular dividends may not provide enough money to live on. Many individuals primary real estate investment is their home, but the recent housing market has undercut home values, from which many homes have not yet recovered. And even in an up economy, your home generally does not produce regular retirement income. You might be able to arrange a reverse mortgage or secure a loan against your equity, but these options will reduce, and potentially eliminate, the value of your equity. Many individuals nearing a retirement age find it useful to sell non-income producing assets and then use the money to purchase a financial product such as an annuity. Annuities can provide income guaranteed to last as long as you live. If you are planning for the future or already living in retirement, an annuity can help ensure your financial security in the years ahead. fixed income + $ 500 annuity $ 5000 fixed expense An annuity bridges the gap between fixed expenses & fixed income
Who should consider an annuity? AN ANNUITY CAN FILL THE RETIREMENT INCOME GAP IF YOU: Want protection, safety and guarantees for your money. Contribute the most you can to employer-sponsored retirement plans such as 401(k) or 403(b) plans and need to save more for retirement. Have already contributed the maximum to a Roth or deductible Traditional IRA or your adjusted gross income prohibits you from contributing to such accounts. Already have investment or savings accounts that can be quickly converted to cash. Need to generate a guaranteed, steady retirement income. Need to ensure a steady income for your spouse or another beneficiary after your death. Expect to be in a lower federal income tax bracket in the future (i.e., because you plan to retire), or you are in a higher tax bracket and seeking tax deferral. Prefer the benefits of annuity investment to other nondeductible investment options such as after-tax contributions to employer plans or non-deductible IRAs, or investment in taxable accounts. Are considering retirement income benefits during retirement, and/or are interesting in guaranteeing annuitization rates. Are looking for protection of principal and/or a minimum guaranteed rate of return. 5
annuity basics How do annuities work? A Fixed Annuity income remains steady, even if returns on other investments slump due to a changing economy, declining interest rates or falling stock prices. An equity-indexed annuity is a type of fixed annuity that offers a guaranteed minimum interest rate that is also linked to an index such as the S&P 500. If the index moves upward, the interest rate generally increases by some amount. But if it moves downward, no less than the guaranteed interest rate is paid. 6 As with any investment, once you decide to purchase an annuity, you will need to make a number of other decisions. The type of annuity you select, the type of contract you prefer and its payout plan, should all be based on your personal retirement plans and your major financial objectives. A Variable Annuity income can rise and fall with your chosen portfolio performance just like it does with any other investment in stocks, bonds or mutual funds. Because there is an associated risk, it s possible that you could earn higher returns but those returns are not guaranteed. Although the value of a variable annuity may fluctuate in the accumulation phase (while you re working), it can be annuitized start making payouts as a fixed annuity. This approach lets you limit the risk to the period that you are still earning other income, and ensures you a reliable, constant payment when you are retired and living on a fixed income. However, if you select a variable payout, the payments will fluctuate even during retirement; if you have other sources of income, it may be worth the risk to potentially earn a higher payout. Higher cost variable annuities may offer an array of optional benefits to guarantee asset value at death, withdrawal income even if asset value declines, and many other features; and they can be extremely complex. While the optional guarantees may fit your needs, the fees can compromise investment performance to the point that overall value is open to question. If you already own a variable annuity, you should maintain it if the death or income benefit is worth more than the current investment value. Another thing to consider when you set up your annuity is how you want to receive payments. There are basically two ways to set up annuity payouts: Immediate Annuity you put in a lump sum of money, and your insurance company begins monthly payments to you right away. Deferred Annuity you put in a lump sum of money or make a series of payments to your insurance company, with payments designed to begin at some future date.
fixed vs. variable annuity fixed annuity variable annuity NATURE OF INVESTMENT Earnings are based on the interest rate established by the insurance company. Lets you allocate your investment through professionally managed stock, bond and cash equivalent subaccounts, with earnings based upon their performance. FUNDING RISK FACTOR Low risk. The contract is backed by the financial strength of the insurance company, which guarantees an unchanging income stream for your lifetime (or for time period you specify). Greater risk, with greater potential returns depending on the performance of the selected subaccounts. APPEAL Ideal for people who want to ensure a steady, level, reliable retirement income. Ideal for people who can afford to take on the potentially negative impact of market risk. They risk a potentially lower income payout, in return for the possibility of a higher income payout. Payouts can be fixed or variable, based on portfolio performance. PAYOUT OPTIONS Either immediate or deferred to a future date, such as retirement. Either immediate or deferred to a future date, such as retirement. OTHER FACTORS Not regulated by the Securities and Exchange Commission (SEC). As with similar investment options, regulated by the Securities and Exchange Commission (SEC). Typically carry higher overall fees, potentially including administrative fees and other charges, as spelled out in the contract or prospectus. 7
Contract types Annuity payout options The contract that ultimately defines your personal annuity will be based on combining the type of annuity you choose either fixed or variable with the payout timeframe you prefer either immediate or deferred. The possible combinations create four annuity options: 1 Fixed immediate annuity You invest a lump sum and your insurance company starts making regular, equal payments to you right away. 2 Variable immediate annuity You invest a lump sum and your insurance company begins making payments right away, but the amount of the payments fluctuates based on the return from the portfolio (i.e., how well those investments perform). 3 Fixed deferred annuity Your payments to the insurance company earn interest at an agreed upon rate, and they guarantee to pay you a minimum annual rate of return until those payouts actually begin either when you retire or at some specified future date. 4 Variable deferred annuity You make an investment choice based on the various stock and bond funds offered by your insurance company. When the payout begins, your account may be worth more or less than your initial investment, depending on how well your chosen portfolio performs. Along with choices about how to fund your annuity and how to structure your contract regarding payment timing, you will have additional payout options: what percent of your payout do you want to receive, and in what increments? Common payout choices offered by insurers include: A lump-sum alternative, which allows you to withdraw the total amount of your annuity. An as-needed alternative, which allows you to withdraw the amount you need as you need it. A systematic alternative, which allows you to withdraw a specified amount until your annuity is depleted. Under the systematic alternative, the amount you receive each month and how long you receive it depends on how much money is in your account and how much you are withdrawing each month. This does not guarantee income for life; when the money s gone, it s gone. An annuitization alternative, under which you may receive either a life option (where the income stream is guaranteed for life by the insurance company) or a period-certain option (where the payout is made over a designated period). This designated payout period could be for as long as you or your spouse are alive, or it could be for a set period, such as 10 years. The chart on the next page looks at common annuitization payout options. 8
payout options It s best to consult a financial planning professional to determine the exact option that works best for you and your financial situation. Remember, payout amounts for each option always depend on the amount of money in your annuity, the payout period you select and your life expectancy (based on age and gender). annuitization payout options guarantees you income stream for life continues to pay your designated beneficiary LIFE OPTION Yes No JOINT LIFE OPTION Yes Yes, but at a lower rate LIFE WITH CASH PAYMENT OPTION Yes Remaining balance paid off in a lump sum PERIOD CERTAIN OPTION No paid over defined number of years only Only if you die before the period expires LIFE WITH GUARANTEED TERM OPTION Yes Yes, but only if you die within the guaranteed term. For example, if the policy includes a 10 year term, and you die in the fifth year of that term, the insurance company is required to continue payments to your beneficiaries (or estate) for the remaining five years. 9
selecting an annuity Because an annuity involves a legal contract as well as investment implications, you need to understand how it affects you and your loved ones in both the short and long term. You will need to name a beneficiary for your annuity, understand the tax deferral implications of your scheduled payout, and be aware of any risks associated with the plan you are considering. And because any contract is only as good as the company holding it, you want to have confidence in the insurance provider that backs the annuity. Important tax information If you take money from your annuity prior to age 59 1 /2, you may incur a 10 percent IRS penalty in addition to any federal income taxes for which you may be liable. For annuities purchased with after-tax dollars, the penalty only applies to earnings. Withdrawal of principal may be subject to insurer penalties. Annuities have a specific tax benefit for most working people. Because your annuity earnings are only subject to federal income taxes at the time you withdraw funds or receive payouts (and not while the annuity is accruing interest), and because you may be in a lower tax bracket when you retire, you may pay less federal income taxes on your annuity earnings. 10
Choosing the right annuity: things to know An annuity is a contract between you and your insurance company. It states that you will give the insurer a sum of money, either in one payment or a series of payments, and in return, that insurer will provide you with periodic payments that begin immediately or at a future date. SOME OTHER THINGS TO CONSIDER INCLUDE: PRE-TAX PAYMENTS Your contributions may be made with either pretax or after-tax dollars, depending on your situation and the terms of your contract. TAX DEFERRALS Consider that an important benefit of an annuity is tax deferral. You do not pay federal income taxes on the annuity s earnings until you withdraw money. At that point, the growth in funds you receive is taxed as ordinary income. If you are retired, you will often make these payments from a lower tax bracket than when you were earning a regular income. GUARANTEED RETURN OF PREMIUM One option for income annuities is a life income that also includes a guaranteed return of premium. Under this option, your annuity payments continue as long as you live. But upon your death, payments will continue to be made to your beneficiaries until the premium has been paid back in full. This is referred to as a guaranteed return of premium. YOUR BENEFICIARY Some annuities offer death benefit protection or the option of continuing payments to a beneficiary after your death. If you die before your payout period begins or at some point during your payout period, your beneficiary may receive a death benefit. The benefit may be the remaining money in your account or a preset minimum. Generally, this benefit is paid to the beneficiary you specify, without the potential cost, delay and publicity of probate bringing peace of mind to you and those you care for. It is recommended that you periodically review all beneficiary designations, and make any needed updates as appropriate. EXTRA CHARGES When considering an annuity, extra costs such as annual fees, investment management fees, administrative fees, insurance expenses and other charges may be incurred. Your contract may include mortality and expense-risk charges as well. Extra features, such as longterm care riders and liquidity options, typically have costs associated with them. Variable annuities typically carry additional fees, expenses and penalties that may affect their value. Any fees and expenses will be listed in the annuity contract, or in the case of a variable annuity, in the prospectus that accompanies the investment fund. SURRENDER FEES Fees are generally charged on partial withdrawals or surrenders from an annuity that take place a certain number of years before annuity payments have begun. These fees, called surrender charges, are usually a percentage of the amount withdrawn. Some deferred annuities offer a free withdrawal privilege that lets you take out a defined amount without a surrender fee. These surrender fees may also be waived if you annuitize, converting your deferred contract into an income stream. EARLY WITHDRAWAL PENALTIES If you take money from your annuity prior to age 59 1 /2, you may incur a 10 percent IRS penalty in addition to any federal income taxes for which you may be liable. Exception: All withdrawal and IRS penalties may be waived if a life-based annuitization is selected. 11
buying an annuity 12
Before purchasing an annuity, look for a reputable, financially sound insurance company. Annuity fees, quality and security can vary widely from one company to another. Comparing insurance companies Selecting the right insurance company is an important decision. Include the following factors when evaluating the financial strength of the companies you are considering: Is the company licensed in your state? Does the company have a reputation for excellent customer service? Remember the following: Annuities are not backed by the federal government. Your annuity contract is only as strong as the insurance company s financial position. Most states have guaranty associations that may preserve some portion of your money if an insurer becomes unable to meet its obligations. However, guaranty associations limit the amounts guaranteed. Is the company highly rated by independent rating agencies (see list below)? Look for a company with consistently good ratings across multiple agencies. Although a company s financial strength may not affect the performance of a variable annuity, it could affect the company s ability to meet the terms of your contract. INDEPENDENT RATING AGENCIES A.M. Best ambest.com Fitch fitchratings.com TOP TWO RATINGS A++ Superior A+ Superior AAA Exceptionally strong AA+ Very strong It may be wise to consult a tax accountant or financial planning professional who can help you select the best annuity for your personal needs both present and future. Moody s moodys.com S&P standardandpoors.com Aaa Exceptional Aa1 Excellent AAA Extremely strong AA+ Very strong Weiss weissinc.com A+ Excellent A Excellent 13
Comparing Products Once you have selected several financially strong companies, begin comparing their annuity contracts. Compare fixed annuities to other fixed annuities and variable annuities to other variable annuities. Be certain you have done your homework by gathering and evaluating important product information. Examine applicable expenses and surrender charges. If considering a deferred fixed annuity, examine the history of the interest rates that the company has paid over time. Are they competitive with other companies? If considering a variable annuity, examine the subaccount managers track record and the subaccounts performance history. How well, and how consistently, has it performed over time? In the back of this brochure, in the RESOURCES section, you will find a Comparing Annuity Contracts tool to help you analyze and compare the annuity contracts you may be considering. SURRENDER PERIOD Most annuities have what is known as a surrender period a set amount of time during which you have to keep the majority of your money in the contract. Most surrender periods last from five to 10 years, and most likely, your contract will allow you to take out at least 10% a year of the accumulated value of the account, even during the surrender period. If you take out more than that 10%, you will have to pay a surrender charge on the amount that you have withdrawn above that 10%. The surrender period allows some level of flexibility to take funds out of an annuity, for cash needs or other investment opportunities. 14
Alternative types of annuities A final reminder about taxes In addition to the traditional types of annuities and payouts examined in this publication, there also are annuities designed to meet special needs or goals. A CHARITABLE GIFT ANNUITY is a contract between you and a charitable organization. You agree to make a gift to the charity and in return, the charity agrees to make income payments to you for the rest of your life. The charity may choose to buy an income annuity from a life insurance company to fulfill the obligation, or it may take on the responsibility directly. MEDICAID ANNUITIES are one of the options individuals have used to ensure they have money set aside to cover health care costs and that they also receive the maximum benefits allowable under their state s Medicaid law. Because available options on Medicaid annuities vary by state, you should consult your financial planning professional for advice and guidance about the choices available to you. A SPLIT ANNUITY option puts two different annuity products to work for you an immediate annuity, to provide monthly income right away, plus a deferred annuity, which is intended to increase in value over time. Once the value of the immediate annuity is depleted, you may begin withdrawals from the deferred annuity. A TAX-SHELTERED ANNUITY (TSA) is also known as a 403(b) Plan. Certain employees of public educational institutions and tax-exempt organizations may be able to contribute to a 403(b) plan, if one is offered by the employer. With some 403(b) plans, you may make pretax contributions to your retirement account which will reduce your income for federal income tax purposes. This makes it possible for you to grow your earnings with taxes deferred. When an annuity is owned by an individual, earnings generally are tax deferred for current federal income taxes. This means that earnings are not taxed until you start taking money out of the annuity. Depending on the type of annuity and how you plan to use it, there can be additional considerations you should discuss with your tax adviser, including treatment of: Gifting (to family members, charities, etc.) Trusts Multiple annuity aggregation (combining various policies) Exchanges Beneficiary designations Federal income tax also may be due on the growth of annuity investments and possibly on the contributions. Consider seeking the advice of a tax accountant. Before purchasing an annuity, learn as much as possible about how they work, the benefits they provide and the charges you will pay. CHANGE YOUR MIND? In most states, you have a specific number of days after purchasing an annuity to terminate your contract and receive a full refund. State insurance departments typically require insurance companies to provide this free-look period, during which you may review your contract 15
resources Annuity worksheet With your financial goals in mind, you should begin any annuity selection process by asking the questions listed below. After you have answered them, your financial planning professional can help you make additional decisions regarding the best annuity for your needs. How do I want to pay into my annuity through a single payment, or through flexible premiums? With a single-premium annuity, you pay the issuing insurance company a one-time lump sum. The required minimum contribution will vary. With a flexible-premium annuity, you make a series of payments to the insurer over time. You determine the payment schedule (monthly, quarterly, semiannually or annually) and amounts (they can remain steady or fluctuate). How do I want my money to be allocated fixed or variable? Fixed annuities earn a steady interest rate set by the insurance company and guarantee an income stream for your lifetime or a specific duration of time. Visit sec.gov/answers/annuity.htm for more details. Variable annuities let you allocate your money across professionally managed stock, bond and cash equivalent subaccounts. Current value and payout amounts may vary with subaccount performance. They offer greater potential returns but are riskier than fixed annuities. Visit sec.gov/answers/annuity.htm for more details. How do I want my money to be paid out fixed or variable? Fixed payout is a guaranteed stream of payments over the life of the annuity. The payout rate is set by the insurance company and the fixed payout amount may be made monthly, quarterly, semiannually or annually. You may have the opportunity to establish a rising income option at the outset of the annuity contract. This will typically provide lower initial income payments, in return for higher income payments in future years. These higher payments are designed to at least partially offset the anticipated higher cost of living in the future. Variable payout is a stream of payments in which the payout amounts may vary with the performance of the subaccounts you chose to invest in. How soon do I want payments to begin immediately, or deferred to a later date (such as my future retirement)? Immediate annuities turn the money you provide into regular income right away usually within 1 to 3 months. Deferred annuities begin regular payouts in the future. A portion of early withdrawals may be subject to a surrender charge. 16
Comparing annuity contracts Different annuities offer a wide range of choices, prices, features and flexibility. Use the following chart to compare annuity contracts you are considering. Write in the names of the companies or specific plans you are comparing under Contract A, B or C. Then compare the features listed on the left for each. Skip items that do not apply or that don t interest you. FEATURES CONTRACT A CONTRACT B CONTRACT C Initial minimum premium Guaranteed rate of return Current rate of return Projected rate of return 3 5 year rate of return Portfolio options Sales charge Surrender charges/penalties Surrender value Other fees Special features 17
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