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What is an Annuity?

What is an Annuity?

Webster dictionary says that an annuity is “a sum of money payable yearly or at other regular intervals." Insurance companies are the main purveyor of annuities and they categorize annuities as being immediate or deferred.

Immediate annuities liquidate an investment called the premium or principal over a specific time period or life where the periodic payment consists of both principal and interest. A deferred annuity issued by an insurance company defers the starting date of the payments indefinitely at the option of the investor while the money grows with tax deferral of investment earnings until withdrawn.

Immediate Annuity 

Immediate Annuity 

Immediate Annuities are products that begin income disbursement immediately at contract inception. The income can be set up for several different contract periods including for lifetime, for a fixed number of years, or even a full or partial continuation of income to be passed to your spouse or other beneficiaries. The income amount for immediate annuities is established and guaranteed when the contract is purchased. Immediate annuities are a great option for investors seeking income and that have other liquid assets available. 

Deferred Annuity

Deferred Annuity

Deferred annuities are products that do not annuitize and start income payments until a later date determined by the contact owner. If a contract owner were to continue to contribute and/or have some investment appreciation the investment value and projected income would increase. Contract owners can even move the investment to other annuity products after the specified minimum term is met and continue to defer taxes on the gains accumulated. Once one annuitizes (elect to turn the investment to income) the insurance company calculates the payments actuarily based on mortality statistics and the length of payment period. 

Variable Annuity Investment Vehicle

Variable Annuities are tax deferred investments that allow the investor to select from a list of investments in an attempt to grow the value. Principal is not guaranteed, and there is the capability and room to grow assets with no cap. Due to there being no cap in investment performance, the insurance company charges a fee to the investor in order to have access to tax deferred investment options. These types of polices can either come in contracts with a specified minimum time frame of commitment or could possibly remain liquid from inception with an additional charge. 

Equity Index Annuity Investment Vehicle

Equity Indexed annuities are a tax deferred investment where both safety of principal is assured and stock market correlated growth is available. In these types of annuities every year your balance will either grow or remain the same. The policy's investment performance will be tied to a particular index, usually the S&P 500. There will be assigned what is known as a participation rate where you can participate in a certain percent of the particular indices growth. For instance, if the S&P 500 went up 8% and your participation rate was 5%, your account would be credited 5% interest. If the S&P were to go down -8%, your account balance would remain unchanged. There is no cost charged by the insurance company. They are compensated by keeping the difference between the participation rate and actual performance over a period of time. These type of policies are offered normally as contracts that have a minimum commitment spanning over several different length options. 

Fixed Annuity Investment Vehicle

Fixed annuities are tax deferred investments where the investor essentially purchases an agreed upon interest rate. The interest rates offered by insurance companies for these types of policies fluctuate year to year based on the economy and interest rate environment. Both the investor's principal and future interest earned are guaranteed by the insurance company. The only risk here is the credit quality of the insurance company. There are no costs charged by the insurance company because they keep the difference in the return they make on your investment and what they have to pay you in interest. While growth is limited in these types of annuities, the safety and guaranteed growth are appealing to conservative investors seeking guarantees. 

Secondary Market Annuities

Secondary Market Annuities

Secondary Market annuities are a very appealing option for both guaranteed income and growth when suitable. These annuities are contracts where the current owner, or seller,  sells or assigns all or a portion of future income for a lump sum. Because the future payments are discounted, potential buyers, or assigners may be interested in purchasing the future income stream. 

The price has to be better than the current fixed product rates in order for buyers to be interested. Secondary market annuities come in all different pay schedules including, monthly, quarterly, annually, and even payments made in larger sums every few years. If you have other assets that provide sufficient liquidity, this type of annuity could be a fit. The guaranteed income and interest are appealing features for those in or nearing retirement. 

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Early withdrawals from these long term investments may result in surrender penalties. Withdrawal prior to age 59½ may be subject to a 10% federal tax penalty. Guarantees rates are backed by the claims paying ability of the issuer. Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Optional riders have limitations and are available for an additional cost through the purchase of a variable annuity contract. Guarantees are based on the claims paying ability of the issuing company. Variable Annuities are guaranteed as to payment of principal and interest by the issuing insurance company. Index annuities are backed by the claims paying ability of the insurance company issuing the contract. Early withdrawal prior to age 59 1/2 may result in a 10% IRS penalty and contingent deferred sales loads. Investment return and principal value will fluctuate so that your shares may be worth more or less than original cost when redeemed. The mortality, expense, and administrative charges and fees are not reflected, and would reduce the performance of the tax-deferred investment if included. Of course, tax-qualified contracts such as an IRA, 401(k), etc. are tax-deferred regardless of whether or not they are funded with an annuity. However, annuities do provide other features and benefits including, but not limited to, a guaranteed death benefit and income options, for which a mortality and expense risk fee is charged. You should discuss this decision with your financial advisor. Securities America and its representatives do not provide tax or legal advice. Tax-law is subject to frequent change; therefore it is important to coordinate with your tax advisor for the latest IRS rulings and specific tax advice, prior to undertaking an investment plan. Any tax or legal information provided here is merely a summary of our understanding and interpretation of some of the current income tax regulations and is not exhaustive. Investors must consult their tax advisor or legal counsel for advice and information concerning their particular situation.

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