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Annui...what?Mar 15 '01 Write an essay on this topic.The Bottom Line Do your research before making any sort of commitment! Now I, myself, am what you might call a novice when it comes to investments. Sure I know what the basic savings account, pension plan, and IRA involves…but if you’re discussing other types of investment strategies such as stocks or annuities? I’m the first one to head toward the door! So actually, this is why I chose to write on this topic. I figured, any information I found might just be that which some potential investors were looking for when attempting to keep their income safe from the IRS until retirement comes along. Although this information might be simplified as you read it, there are many of us who will benefit from such explanations…so grab a pencil and paper and learn along with me! Annuities: What exactly is an annuity? Well, an annuity is considered to be a medium through which people choose to invest tax-deferred money, usually to be used for retirement or upon your death. It is essentially a long-term contract between you, as the policyholder, and an insurance company who takes your money and invests it for you. The bottom line is that you give a company your money in return for a guarantee of a steady stream of money into your bank. The time in which you keep the majority of your money within the contract is commonly termed the “surrender period.” Usually, you will be allowed to invest your money in an annuity until the age of 59 ˝, at which point the government requires you to begin accepting payments or risk facing a penalty on your funds. The value of any type of annuity you choose is ultimately going to vary, and it is one of the riskier types of investments to make, so you need to understand what you are getting yourself into before you sign any sort of contract or make any permanent decisions regarding these annuities. How do I purchase an annuity?: An annuity can be purchased through an insurance company, brokerage firm, bank or mutual fund company. You can purchase an annuity with a lump sum of money or, if you prefer, a number of large payments over a period of time. This money that you put into the annuity will grow untaxed for as long as it remains untouched within that annuity. The person that invests the money into the annuity is commonly known as the “owner” and has the option to make changes or add co-owners at any time during his or her ownership of the policy. When purchasing the policy, the individual owner will also need to name a beneficiary, so that when they die, the said beneficiary will receive the remainder of the invested money. Types of Annuities: There are essentially three types of basic annuities to choose from: -Fixed Annuity- this type of annuity is pretty much as the name implies, an annuity throughout which the interest rate stays constant. Usually what you will find with fixed annuities, is that the longer the fixed term of interest, the smaller the amount of interest will be offered your money until it is withdrawn. This type of annuity would be a good choice for an individual who wants a lower-risk type of annuity investment to ensure that the money will still be there upon retirement. The money within a fixed annuity will remain tax-free, as will the interest that grows on your initial deposit, until you begin receiving your benefit payments. This type of annuity will contribute to a steady source of income for the investor upon retirement, but you must also note that by agreeing to the terms of a fixed annuity, you are essentially stating that you will never be able to touch that money again aside from the monthly payments issued to you by the company. The amount of income you will receive in payments is determined by your current age, the interest rates at that time, as well as the amount of time you have indicated you would like to receive payouts by the said company. -Variable Annuity: the variable annuity is actually the more popular of the three types of annuities, but carries with it a greater degree of risk than say, the fixed annuity. The variable annuity is also a contract with a particular company for a set amount of time, throughout which you are able to buy and sell various mutual funds as offered by the selling company. It allows the buyer to have a great deal more say in the “when” and the “how” of their money and thus feel they have more control over their return. This type of annuity carries with it the same benefits of tax-deferment until the payouts begin, no matter how many times the owner buys or sells their mutual fund choices within the time frame of the contract. Another draw to this type of annuity is the fact that no matter how poor or well your mutual funds actually do according to the stock market over time, the investor is guaranteed to receive no less than the original lump sum they deposited into the account in the first place. -Index Annuity: this is the most relatively recent addition to the family of annuities, and involved tying ones investment into a particular stock market index such as the Standard & Poor’s 500 index. As with the others, this annuity also involves contracting your money to a particular company for a period of time. However, unlike the variable annuity which allows the owner to choose their own mutual funds as part of their portfolio, in an index annuity the company will be choosing which stocks to invest your money in. The index annuity protects the investor, though, in the sense that they will only be receiving a certain percentage of the overall gain or loss as indicated by the stock market instead of the 100% ramifications…which can serve as a downside if there is a booming market, but ultimately protects the investors if the market fails over time. Why do we hear so much about annuities?: Part of the reason that annuities are so popular with various companies, is once again the fact that it ensures a guaranteed stream of income upon retirement along with the extra benefit of both the initial investment, as well as the interest that investment accrues being tax-deferred. But, another important thing to keep in mind is that annuities carry one of the highest percentages of commission for brokers who sell them…sometimes averaging as much as five to six percent of the money you originally invested. For this reason, when consulting any type of broker, one of the first options they will offer you is an annuity. By understanding exactly what this type of investment is, you will be greater prepared to accept or decline on your own personal terms. If in doubt, do not hesitate to check with a second party on your decision. Taxation , Withdrawal, and Fees: Taxation on annuities first begins when the owner either chooses to remove their investment in one lump sum or receive small payment installments from that investment over a period of time (this latter choice is also known as annuitization). The money you receive on your annuity will come on a “last in/first out” basis which basically means that the first money you will see is that of the earnings, not of the principle. The taxes one will pay on the annuity will depend on the type and the current status of the market. For example, the fixed annuity will already have maintained a specific tax rate upon the owner signing the contract with the company, but the market value of both the variable and index annuities will change depending upon the actual market numbers. There are several types of fees which can be affixed to your annuity in certain circumstances such as a management type of fee for changing mutual funds frequently within a variable account or a surrender charge for withdrawing your money before the contract has expired with the company, but as always rules will change depending on the type of contract, annuity, and company so make sure you read the fine print. Final Thoughts: It seems that annuities can be an excellent type of investment for those searching for a steady source of income during retirement as well as those individuals that can afford to invest their money over a long period of time. From the information given, annuities are not a popular choice over a standard IRA and should not be looked at as a viable alternative unless the individual already has a secure IRA within their investment portfolio. Much of the advice offered suggests that an annuity should only be considered if one has contributed to the maximum allowed in their retirement account, likes the idea of having a greater say in where their money is going and has a basic understanding of mutual funds, has a high tax bracket now but expects that bracket to decrease upon retirement, and can prove to be a longer-term investor. The choice is ultimately up to the individual…but these are some of the points, tips, and tricks that I’ve come across in my preliminary investigation on annuities. There’s plenty more out there and this information is in no way intended to take the place of a knowledgeable financial advisor, just a few quick thoughts for those of us who don’t have a clue when it comes to investing and have wondered about it a time or two. Many thanks to various sources such as Suze Orman’s invaluable book, “The Courage to be Rich” and the excellent web site at www.motleyfool.com which houses an enormous amount of financial information for the novice to the professional investor. Thanks for reading and have a wonderful day!  |
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