All About Annuities

By Tim Mammadov

All About Annuities

Understand the types of available annuity plans, including deferred annuities, indexed, fixed rate, lifetime, and more.

By Tim Mammadov

OverviewAn annuity is a financial vehicle that guarantees you an income stream and can be used as an important supplement to your retirement plan. Capital gains and dividends in an annuity are tax exempt, and the distributions are taxed at your income tax rate, under 2009 Internal Revenue Service (IRS) rules. There is a variety of annuity products created over the years by insurance companies. However, there are a few major types of this instrument that are the most popular.Deferred and Immediate AnnuitiesThe two major types of an annuity are deferred and immediate.
In a deferred annuity you make contributions to your account over time (this period is called the accumulation phase). You can opt to have your account grow at a fixed interest rate (which is safer, especially in the 2009 economy) or as an investment account (think of it as a mutual fund where you deposit your money, performance of which can go up and down depending on the market). Any gains or dividends in the accumulation phase are not subject to taxation and are deferred until you begin taking distributions, which then are taxed at your income tax rate, just like any regular retirement plan. And, similar to an Individual Retirement Account (IRA) or a 401(k) plan, you can begin taking money out of an annuity only after the age of 59-1/2. Otherwise, the IRS imposes a penalty of 10 percent for early withdrawals. However, even though you are limited to when you can begin accessing your account, the tax rate will be lower since retirees are placed in the lower income tax bracket.
In an immediate annuity you make one lump-sum contribution with your after-tax earnings to your account and then can begin taking distributions out starting in the following month. Whatever your put in the account will never be taxed as it was already taxed once, and the capital gains and dividends portion of the account will be taxed as regular income.Fixed and Variable AnnuitiesOnce you have decided you need that extra income stream from your annuity account, the amount of cash you can receive each month will depend on the annuity type you have set up.
A fixed annuity pays out fixed amounts each pay period, which means you can plan your budget without worrying about how the market is performing. The only downside of this type of annuity is that in case of a growing economy and positive market growth you will not be participating in these extra gains. However, with a variable type of annuity, your funds are deposited in an investment account, performance of which will depend on the underlying investments, just like in a mutual fund. The payout amounts in this case are not fixed and will vary each period. You can opt for a guaranteed income rider that will fix a certain payout amount each pay period, but anything in excess of that amount will depend on your account’s performance.
Whether you should choose a fixed or variable annuity will depend on your budget and risk tolerance.Fixed Period and Lifetime AnnuitiesThe length of time over which you will receive distributions from your annuity account depends of what you prefer: payouts over a fixed number of years, 10 or 20, for example, or an income stream over your entire life.
With the fixed-period annuity the income stream does not stop with the death of the annuitant and will continue to be paid to his beneficiaries. A lifetime annuity will stop distributions once the annuitant has deceased regardless of how long ago the distribution phase has started. In a two-life annuity the spouse of the deceased annuitant will continue to receive income for the rest of her life as well.Qualified and Non-qualified AnnuitiesWhether your annuity is eligible to be set up as a retirement account or not depends on the type of the annuity: qualified or non-qualified.
As the name implies, a qualified annuity can be set up as your IRA or a 401(k) and the contributions will be made with pre-tax earnings. The distributions will be taxed at your income tax rate at the time they begin and there is no other taxation.
A non-qualified annuity cannot be set up as a retirement plan and the contributions are made with after-tax earnings. The distributions are still taxed at your income tax rate, but only the earnings portion of them, since the initial amount had already been taxed.ConclusionAnnuities are an excellent tool that should be considered as part of your retirement planning. However, this product is complex and has many different options/riders. If you decide to open an annuity account to supplement your income at retirement, make sure you consult your financial planner in order to make the best choice possible for your particular situation.ResourcesreferenceWhat is an Annuity?referenceIRS: Pension and Annuity Income

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REFERENCE/RESOURCE: What is an Annuity?
REFERENCE/RESOURCE: IRS: Pension and Annuity Income
REFERENCE/RESOURCE: Contact Us,Terms & Conditions,Back Issues,

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