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Ultimate Guide to Deferred Annuities

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Thursday, 09 Oct 2014 09:37 AM Current | Bio | Archive

If you plan to wait a number of years to tap into your annuity income, you should take a close look at deferred annuities.
 
One key benefit to any deferred annuity is your money will grow tax-deferred. The earnings are only taxed on withdrawal, which gives the annuity a tax benefit. Because of these tax benefits, there may be tax penalties for early withdrawals taken prior to age 59 1/2, so you should consult your tax professional regarding your own personal situation.
 
Deferred annuities are either variable or fixed. The difference lies with who is assuming the risk for the underlying investments. With fixed annuities, the insurance company assumes the risk. With variable annuities, the annuity holder assumes the risk.
 
Here’s how deferred annuities are broken down:
 
Fixed Annuities
Sometimes referred to as traditional fixed annuities, fixed annuities are similar to CDs in that the interest rate is locked in at the time of purchase.
 
With a traditional fixed annuity, the interest rate is guaranteed for up to 10 years. The interest rates are generally a little higher than what you would find at a bank on a CD, and the interest is tax-deferred until you withdraw it.
 
With fixed annuities, the insurance company declares and guarantees an interest rate for a defined period of time. As the insurance company assumes the risk, this type of annuity is a good fit for someone with little risk tolerance. And, conveniences like that, coupled with safety and predictability, make fixed annuities a popular option for those looking to supplement a retirement income rather than fund retirement.
 
However, some consider the locked-in interest rate to be a downside of fixed annuities. While the locked rate might be appealing, it comes with an expiration date. After the specified term, the rate could dip to a low you’re unhappy with.
 
Fixed Indexed Annuities
Fixed indexed annuities have been referred to by many names, such as “index annuities” and “equity-indexed annuities,” but the common denominator is that these products run in the middle of the risk road.
 
If you are not willing to risk your principal but are willing to gamble a little with the amount of interest you could earn, you might have the temperament for an indexed annuity. That’s because the interest rate is flexible, unlike the locked-in rate of a traditional fixed annuity.
 
If you are intrigued by fixed indexed annuities, you’re not alone. In 2012, sales of indexed annuities set a record $34 billion, according to the Life Insurance Marketing Research Association. That figure is six times the amount of indexed annuities sold in 2000.
 
Like a traditional fixed annuity, a fixed indexed annuity offers protection for your money. It pairs a guaranteed minimum interest rate return with the opportunity to earn higher returns based on the performance of the index it is linked to.
 
The interest rate with these products is linked to changes in an economic index, like the S&P 500 or Nasdaq.” If the S&P 500 has a down year, the annuity won’t participate in any financial loss due to a downturn in the index the annuity is linked to. And if the index has a gain, the annuity receives a boost in the interest rate for that year.
 
The index is only a factor that in part determines the interest to be credited; an indexed annuity does not participate directly in the stock market or in an index’s gains or returns.
 
There are drawbacks, though.
 
First, some of these products are complex. With certain indexed annuities, it can be difficult for owners to understand all the twists built into the contract. And because indexed annuities all calculate gains in different ways, it can be tough to pinpoint exactly what your return will be if an index has an “up” year.
 
To compensate for the downside risk protection, indexed annuities generally don’t match the full return of an index but instead give you only a portion of the index’s overall return or limits your gain to an annual cap. In some years the interest credited on an indexed annuity could be less than what would have been credited with a traditional fixed annuity.
 
However, in comparison to a traditional fixed annuity, fixed indexed annuities offer greater potential for growth. Generally speaking, indexed annuities (as well as traditional fixed annuities) are designed for accumulation over a period of years while you enjoy the benefits of your gains being tax-deferred.
 
They shouldn’t be looked at as temporary savings accounts for a down payment on a house or other short-term needs.
 
Variable Annuities
The riskiest member of the annuity family is also the most flexible.
 
A variable annuity allows you to allocate your annuity to participate in a variety of investments. Variable annuities offer the greatest opportunity to beef up your savings through long-term growth, and that high-growth potential means a variable annuity is the most likely of the annuities to outpace the rate of inflation, a benefit you could realize when you turn on the income stream later in life.
 
But all that growth comes with hazards.
 
Unlike traditional fixed and fixed indexed annuities, variable annuities come with risk to principal. As with a mutual fund, the variable annuity owner assumes the risk of the underlying investments — thus your principal is at risk, so you can lose money.
 
Variable annuities have two phases: the accumulation phase and payout phase.
 
In the accumulation phase, you allocate your money to investment options that could consist of a dozen or so different stock or bond mutual-fund portfolios called subaccounts.
 
Then you have to hope they perform well so, at a minimum, they maintain the value of your annuity contract and ideally grow and offer high returns.
 
During the accumulation phase, you can transfer your money from one investment option to another, but the insurance company may levy a fee for those moves.
 
The payout phase is exactly what it sounds like: the time when you start receiving distributions from your annuity, including the gains, if any.
 
However, this is one feature of variable annuities that’s often tough to grasp because payout amounts are tied to a moving target: the performance of your investment options.
 
Variable annuities can be very complex, so a full understanding of what you are buying is imperative. In addition to what the adviser tells you, read the prospectus, do your own homework on the underlying investment options, and consult with an additional expert — such as an outside adviser, your CPA, or an attorney.
 
Variable annuities can be more laden with high annual fees than other annuity funds and can include the annual insurance charge, which can run 1.25 percent or more; annual investment management fees, which range anywhere from 0.5 percent to more than 2 percent; and fees for various insurance riders, which can add another 0.6 percent or more. Combined, you could be facing a price tag for fees from 2 to 3 percent a year, or more.
 
Those fees could put a serious crack in your nest egg and could even cancel out some of the benefits of a variable annuity — especially when you compare the fees to a regular mutual fund that may charge an average of 1.5 percent a year or to fixed indexed annuities that have most costs built in to the contract in the form of caps, margins, and participation rates.
 
With a variable annuity, owners receive a prospectus that outlines all fees. Owners should read that prospectus carefully and ask their agent or adviser any questions and share their concerns.
 
There’s also a tax wrinkle with variables. If you build up long-term capital gains in those stock and bond subaccounts, those gains are taxed at ordinary income rates when you withdraw them. So high-income individuals are essentially converting long-term capital gains into ordinary income and can face higher tax rates.
 
You can find out more about how to Increase your retirement income by 30 percent in Crown Atlantic's new report, "The Annuity Primer: Get Guaranteed Income for Life." Go online to CrownAtlantic.com/Protect or call today 855-221-5546.
 
Joe Stark is the CEO of Crown Atlantic Insurance, LLC in Boca Raton, Fla. Stark is an insurance industry veteran with more than 25 years of experience. For more of his reports, Go Here Now.
 
 

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JoeStark
If you plan to wait a number of years to tap into your annuity income, you should take a close look at deferred annuities.
Ultimate, Guide, Deferred, Annuities
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2014-37-09
Thursday, 09 Oct 2014 09:37 AM
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