Most people think annuities are simple: you hand over a lump sum payment, agree to wait a certain amount of time, and then you start receiving monthly checks. But annuities are complex investments that come in many different packages. They can offer tremendous benefits if set up correctly and provide a steady stream of income during retirement.
If you are thinking about an annuity, here are 10 things to know before you buy.
1. Deferred Annuities Offer Tax-Advantaged Savings For Retirement
A deferred annuity has two parts: the accumulation phase and the payout phase. In the accumulation phase, your money sits and grows over time, building up the value the longer you wait. You are in control of when you decide to start drawing income from the annuity. Therefore, you are also in control of when you will start paying taxes. During the payout phase, you will likely be in a lower tax bracket than during your working years, allowing you to keep a larger portion of your income.
2. There Are Ways to Reduce The Taxes You Pay
One of the potential drawbacks of a deferred annuity has to do with the way you withdraw money and the taxes owed on the payments you receive. Essentially, you are receiving earned interest first, which is taxable, before being paid back your principal, which is tax-free. A way around this is to convert a deferred annuity into an immediate deferred income or immediate income annuity. With these types of annuities, the monthly payment you receive is a mix of principal and interest, so only a portion of the payment is taxable.
3. You Can Switch Out Of One Annuity And Into Another
If you decide that your current annuity no longer fits your needs, under most circumstances you can switch into a different annuity without any tax consequences as a “1035 exchange.” For example, if you invested in one type of annuity in your 40’s or 50’s and now find that in your retirement years you prefer a fixed-rate annuity, you can make the switch, and as long as you had your original annuity long enough, there would be no surrender fees.
4. A Life Insurance Policy Can Be Swapped For An Annuity
If you have a cash-value life insurance policy that is no longer needed, you can use a “1035 exchange” to switch the life insurance policy into an annuity tax-free. As an example, if you convert a life-insurance policy into an income annuity, your policies’ cash value immediately becomes a stream of income when converted. And by converting to an annuity, you decide how long you want to receive that income by setting the terms of the annuity.
5. Red Flag: Fixed Index Annuities Have Some Drawbacks
The allure of a fixed index annuity is strong. You get to participate in the gains from a rising stock market without any worries of losing money in down markets. But the upside gains are capped, and depending on those caps, you may be losing a considerable amount. For example, a fixed index annuity may have a 6% cap rate. If the index gains 5% in a year, you may get all 5% credited to your account. But if the index gains considerably more, like 10%, you would only get 6% since your gain is capped. The annuity could also carry a participation rate, meaning you’ll get even less of the actual index gain. Be sure to read the fine print and shop for the best deal.
Come back to The Capitalist tomorrow for part 2 of the list.
Part 2: Thinking About Annuities? Here Are 10 Things You Need To Know
Yesterday we covered the first five things you need to know about annuities, from their tax advantages to the ability to switch from one annuity to another. Today we cover the last five things you need to know if you are considering an annuity as part of your retirement plan.
6. Some Annuities Make Sense In A Tax-Deferred Retirement Account, Others Don’t
Putting a tax-deferred annuity inside a tax-deferred retirement account like an IRA might sound like a waste. But for some types of annuities, like a fixed indexed annuity, it can actually make sense. As we covered yesterday, fixed indexed annuities allow you to take advantage of the index’s upside without worrying about a loss. A deferred income annuity can also make sense in an IRA. This is if you plan on starting your withdrawals at age 72 as required. The type of annuity you should not have in an IRA is a variable annuity. After all, the fees for tax deferral don’t make sense in tax-deferred IRA.
7. Make Sure You Understand The Fees of “No Load” or “No Fee” Annuities
The issuer of the annuity needs to turn a profit after paying commissions and covering expenses. So even “no load” or “no fee” annuities have fees, these costs are just called something else and baked into the product. For fixed annuities these costs typically aren’t large enough to matter. For some variable annuities, however, buyers should pay attention to fees and costs. They should get a clear understanding of what they are paying and what additional costs they could incur before signing the paperwork.
8. Naming Someone Other Than A Spouse As Your Beneficiary Create A Tax Event
If your spouse is named as your sole beneficiary, upon your passing they will have the option to file a claim taking the entire distribution. Alternatively, they can assume ownership of the annuity, avoiding a taxable event.
A non-spouse beneficiary won’t have the option to assume ownership. Additionally, he or she will have to pay taxes on the increase in value of the annuity when it is distributed to them.
9. You Will Pay Penalties For Early Withdrawal – But There Is An Exception
Just like if you took a withdrawal before 59 ½ on any other retirement account, you will pay a 10% penalty plus ordinary income tax to the IRS if you start withdrawing from your annuity before you turn 59 ½. There is an exception, however. If you take a payout from a lifetime income annuity and immediately put that money into an immediate income annuity, you aren’t subject to the penalty and can start receiving annuity income before 59 ½ years of age.
10. Red Flag: The Annuity Salesperson Might Not Have Your Best Interests In Mind
Selling annuities requires state licensing. However, the person selling you the annuity does not have to meet the “fiduciary rule” meaning they are acting according to your best interests. Instead, they only have to meet the “suitability standard” which is a much lower ethical requirement. The suitability standard only means that the salesperson is selling you something that is suitable, not necessarily your best option.
Interested in learning more about annuities and how they can help you reach your retirement goals? Speak with your financial professional to discuss your options.
The S&P 500’s 16-year Most Acclimated Journey
The most momentous moments of the last 16 years. The S&P 500’s journey 1000 to 2,000 point level for the first time, as market momentum continues to drive stock gains.
Find out the top winner and losers in last 16 years.
Monster is the top winner and AIG is the top loser on her list. Of course, that all depends on the pace of rate hikes, with slower gains generally seen as better for stocks.
How to Invest: 15 Questions to ask your Broker
Before you decide on a broker, ask the following questions. If they can answer without hesitation, you’re headed in the right direction.
1. How long have you been a broker?
2. Can you tell me about your company’s financial condition? (ask to see their balance sheet)
3. How are your relationships with major banking institutions?
4. Where do you get your rate quotes from? (broker, bank or banks)
5. Are your spreads variable or fixed?
6. How tight are your spreads?
7. Does your brokerage offer fractional pip pricing?
8. What, if any, are your firm’s trading restrictions?
9. Do you permit scalping?
10. Will I earn interest on positive rolls?
11. Is there an opportunity to earn positive rolls at all margin levels?
12. Where are your rollover rates displayed?
13. Does your trading platforms allow hedging?
14. Do you have any policy in place to prevent me from losing more money than I put into my account?
15. Do you offer around the clock customer service availability?
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