Trust & Investments Information Center
Annuities are investments that offer investors many unique benefits. Think of them as the opposite of life insurance. Insurance protects you financially against dying too soon. Annuities try to protect you against living too long and having your funds run out prematurely.
An annuity is an agreement between an investor and an annuity provider (customarily an insurance company). The investor agrees to place money in the annuity, and in return, the provider agrees to pay the investor an income, usually for life. Annuities are also popular with investors who wish to “park” large cash deposits, because the income grows tax-deferred until withdrawal. However, withdrawal prior to 59½ may result in a 10% tax penalty.
Annuities offer the following unique benefits:
They are tax-sheltered
They provide income
They qualify for direct rollovers
They allow investors to bypass probate
They may reduce taxes on Social Security
Major Types of Annuities
In a fixed annuity , the principal amount invested grows at a fixed rate of interest, and the investor knows from year to year how much money is being earned. This form of annuity places the investment risk on the insurance company; and if the investment performance is insufficient to fund the promised rate of interest, the insurance company must make up the difference.1
A variable annuity has no fixed rate of interest, and earnings depend on the investments you choose, whether it be stock, bond, or money market funds. They also give the investor the flexibility to change the investment as his or her circumstances change.1,2
An indexed annuity is tied to a stock market index such as the S&P 500. This type of annuity allows the investor to participate in market gains and at the same time protects them from market declines. There are a number of these annuities available, each with its own unique features. The common denominator, however, is market participation without principal risk. The market participation varies, as do minimum guarantees. While the market may or may not increase, most contracts offer a minimal rate plus a return of the original principal.3
There are also several purchase and payout options associated with specific annuities.
A single-premium annuity is a good choice for an investor who wishes to make an investment all at one time without adding to it later.
A fixed installment annuity allows an investor to build an investment fund with regular payments over time that earn the rate of interest as investments accumulate. This option is appropriate for someone who wants to begin investing, but doesn’t have a large, initial amount to get started.
Flexible annuities enable investors to add funds in any amounts and whenever they choose to their initial investment.
As the name suggests, an immediate annuity starts making payments to the investor immediately, usually within one month. It is designed for investors who want to convert accumulated capital into income payments that begin right away. The owner may not withdraw any cash beyond the regular payments, and must relinquish control of the principal once payments begin.
A deferred annuity allows the investor to postpone payments. This is the most common type of annuity which provides the opportunity for the investment to grow over time, increasing in value.
Tax Considerations of Annuities
When annuity payments begin, only part of the payment (the previously untaxed earnings growth) is subject to income tax. Your annuity company will tell you how much out of each payment will be excluded from taxes determined by a formula called the exclusion ratio. The original principal invested with after-tax dollars is not subject to taxation, and the previously untaxed earnings may be taxed at a lower rate depending on the annuitant’s age and income level. A tax-deferred annuity can be an important part of your long-term savings and retirement strategy, but needs to be tailored to your unique situation. Your representative can help you find out more about how this investment option could fit into helping you save on taxes today and secure income for tomorrow.
1Product and product features vary by state and insurance company. Withdrawals made prior to age 59 1/2 may result in an IRS penalty. Guarantees are based on the claims-paying ability of the issue.
2You should consider a variable annuity’s risks, charges, and expenses carefully before investing. Contact your Financial Advisor to request a prospectus, which contains this and other information about a specific variable annuity.Read it carefully before you invest. Past performance is no guarantee of future results. Investment return and principal value of a variable annuity will fluctuate, causing shares, when redeemed, to be worth more or less than their original cost.
3You should consider an equity indexed annuity.s risks, charges, and expenses carefully before investing. Equity indexed annuities often have features such as limits on the rate of return available, and minimum guaranteed rates of return. Further, these vehicles do not allow for participation in dividends accumulated on the securities represented by the index. Withdrawals made prior to age 59 1/2 may result in an IRS penalty. Pre-mature surrender charges, premium bonuses,and multiple premium payment arrangements may apply. Equity indexed annuities are not suitable for all investors.1>