All About Annuities
What part should annuities play in your retirement planning?
Life insurance pays once the insured person dies. An annuity pays as long as you stay alive.
An annuity usually includes a guaranteed minimum return; for example, you may get back at least as much as you pay in. The annuity might also include an insurance feature, meaning there is a death benefit in addition to the payouts.
The three kinds of annuities are fixed, variable and equity indexed. With a fixed annuity, you get a guarantee that you will earn a minimum interest while your account is accumulating. The company also promises to make a minimum payment each month; these payment might last for a specific number of years, or for the rest of your life.
A variable annuity allows you to pick investments where you want your money deposited. These are usually mutual funds within a family of funds. The interest you earn and your periodic payments rely on the performance of the investments you pick.
An equity indexed annuity provides you with a net return based on performance of an index, such as the S&P 500, along with a minimum return guarantee. At the end of the accumulation period, you can take periodic payments or a lump sum payout.
Variable annuities are treated like securities and are regulated by the Securities and Exchange Commission (SEC). An equity indexed fund might also be a security, based on the mix of a program's features. Most equity indexed funds are not regulated by the SEC.
For most investors and individuals saving for retirement, the variable annuity is the most important of these types. Although this product is very similar to a mutual fund, some important differences should be kept in mind as well.
First, the annuity feature guarantees payments that you will receive for the rest of your life; this feature is not found in the mutual fund contract.
Second, the variable annuity includes a death benefit, meaning it has attributes of a life insurance policy. Your beneficiary receives the death benefit even if you die before making all of the scheduled annuity payments.
Third, income under the variable annuity is tax deferred so that you do not pay tax on any profits until you begin withdrawals. You are also allowed to transfer funds among the mutual fund options within the variable annuity without any tax liability. When you begin taking cash out, all of the earnings are taxed as ordinary income; no capital gains rates apply.
Knowing the particulars of annuities, and especially of variable annuities, helps with retirement and investment planning. Because variable annuities are securities, shares are usually bought within a qualified plan or through a financial adviser.
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