Joe Marullo Insurance & Retirement Services
16818 Doverwood Way
Houston, Texas 77058
In its simplest definition, an annuity is a written contract between the annuity owner and an insurance company. For our purposes, however, an annuity describes a contract offered by an insurance company that allows you to accumulate funds for retirement on a tax-deferred basis. Upon retirement, you'll receive income from the annuity that the insurer can guarantee to last either a fixed number of years or as long as you live.
Your value in an annuity contract equals the premium payments you pay in, plus interest credited, less any applicable charges. The insurance company uses this value to calculate the amount of the benefits you'll receive from them when you begin taking distributions. An annuity is neither life insurance nor a health insurance policy, and it's not a savings account or a bank Certificate of Deposit.
An annuity is an investment vehicle primarily for accumulating retirement savings. Again, you pay premiums to the insurer, and, in return, they pay you an income stream at a later date. Based on this description, you'll see that there are two phases to an annuity:
During the second phase, called the Payout phase, the company pays income to you or anyone else you choose. Unlike many other retirement savings instruments, you will typically have flexibility in how you receive your funds. For instance, you can choose to accept, say, a 10-year payout, 20-year payout, or even a lifetime payout of income.
The two primary reasons to invest in an annuity are:
There are other strategic estate planning situations where annuities may be warranted, but these will depend on your specific financial situation. The rest of this guide will focus on understanding how annuities work, the various types that exist, and what role annuities should play in your financial planning.
While annuities might seem complicated at first, they become easier to understand by breaking them into the following components.
There are two broad classes of annuities: "Deferred" annuities and "Immediate" annuities. In addition, each type has numerous sub-classes.
A deferred annuity is most appropriate for people who want to:
With a deferred annuity, you pay a premium to the insurance company, which issues a contract promising to pay interest made on the premium while deferring the income and the taxes until you withdraw the money or begin receiving an income.
A fixed deferred annuity pays a guaranteed "fixed" interest rate (based on the current market rates of interest) where the earnings compound and grow tax-deferred. Thus, fixed annuities offer safety from market risk in typical day-to-day market fluctuations in stocks, bonds, or other investment markets. However, since this rate of return is fixed, it is essential to consider the impact of inflation on your investment.
You will also want to consider the financial strength of the annuity-issuing insurance company since they guarantee the return of principal and interest. Several independent financial analysis companies such as A.M. Best and Standard & Poor's will rate the strength of such insurance companies for you.
A fixed-indexed annuity differs from a fixed deferred annuity in that the rate of return on your investment is based upon the better of either a) the growth of a named stock market index, such as the Dow Jones Industrial Average, or b) a minimum guaranteed interest rate.
Many fixed-indexed annuities offer you a portion (not a full 100%) of the index gains. Still, this type of annuity does allow for potentially higher returns than a typical fixed annuity since you can participate in a rising stock market yet be protected on the downside by the minimum guaranteed rate of return.
A variable annuity allows the flexibility to invest your funds in a wide range of investment options through "sub-accounts." Sub-accounts are somewhat similar in design to mutual funds and allow for investing in stocks, bonds, money markets – even guaranteed fixed-rate instruments.
The ability to choose and change investment options provides you the advantage of participating fully in any market gains (not fractionally), thus potentially providing even higher returns than fixed-indexed annuities. However, unlike fixed-indexed annuities, many (though not all) variable annuities offer no guaranteed rate of return. Therefore, the value of the variable annuity and its sub-accounts will fluctuate day-to-day, based on the performance of the underlying investments you choose.
Such an annuity may be better suited for those investors with a longer-term time horizon who can afford these day-to-day market gyrations. As with a fixed annuity, any gains in the variable annuity credited to the account are tax-deferred until the funds are withdrawn. However, unlike a fixed deferred annuity, your funds are not guaranteed by the insurer against market fluctuations, including a risk of principal loss. A key benefit of variable annuities is the ability to transfer assets among the various investment options, as necessary, in response to market conditions or your changing investment goals without incurring current taxes on any capital gains and/or income.
An Immediate Annuity is most appropriate for people who want to:
The immediate annuity allows you to deposit a lump sum and begin receiving regular payments generally within one year after the deposit. It is usually funded with a single premium purchased by retirees with funds they have accumulated for retirement. These annuities can provide a predictable stream of payments that will continue for the rest of your life or for a time period you choose.
The choice of fixed versus variable annuity depends primarily on the investor's specific needs.
A Fixed Annuity is most appropriate for people who want to:
You will have several options for deciding how you want to receive your annuity income. However, here are a few things to consider before making your decision:
Life expectancy continues to increase. The average person living a healthy lifestyle may expect to live longer. Studies show a 48% chance that one member of a couple age 65 today will live to be age 95. So it is conceivable that you could spend as many years in retirement as you worked towards retirement.
In the past, defined plans such as Social Security and an employer-sponsored plan were the primary sources of retirement income. Today, these plans provide a smaller portion of retirement income, requiring you to provide a more significant portion of your retirement income.
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