Annuities

What is a Tax Deferred Annuity?

A “tax-deferred” annuity is an annuity in which taxation of interest or other growth is deferred until it is actually paid. The contract owner contributes funds to the annuity in a lump sum or through annual payments to the annuity. The money is then allowed to grow for a period of time on a tax-deferred basis. At a future date the money is “annuitized”, and accumulated funds are paid out, generally through periodic payments made over either a specified period of time, or the life of an individual or the joint lives of a couple.

Annuities are used for many purposes in addition to providing lifetime income. They may be used to accumulate funds for some future event, e.g. education, a court settlement, or a lottery.

What are the tax advantages of an annuity calculator?
What is the future value of an annuity calculator?

Types of Annuity Contracts

  • Method of Purchase; Annuities can be purchased with a single lump sum of cash; referred to as single premium annuities. Or they may be purchased with installments either fixed or flexible over a period of time.
  • When Annuity Payments begin; an “immediate” annuity is purchased with a single premium, with annuity payments beginning one payment period (monthly, annual, etc.) later.
  • Investment Options; during the period before a contract is annuities, the funds invested by the contract owner are put to work. Depending on the type of annuity, the underlying investment vehicle will vary.

1. Fixed Annuity; In a fixed annuity contract, the issuing life insurance company will guarantee a certain rate of interest, for a specified period of time. Such annuities are useful for conservative, risk averse individuals. The investment risk rests on the insurance company, and the ultimate annuity payments are relatively predictable.

2. Variable Annuity; A buyer of a variable annuity contract has the options of investing the funds in the contract in a variety of insurance company “sub accounts” which operate much like mutual funds. The investment risk rest largely on the contract owner. Annuity payments are linked to the value of the underlying investments, which can fluctuate up or down.

3. Equity-Index Annuities; These annuities combine a guaranteed minimum interest rate, with a potential for greater growth linked to a specific equities market index such as the Standard and Poor’s 500 index. If the chosen index rises sufficiently during a specific period, a greater interest rate is credited to the contract owner’s account for that period. Unlike variable annuities, where poor market performance can lead to decreased contract values, equity-indexed annuities are structured to not lose value due to a declining stock market.

Annuities like other investments have an important place in an individual’s portfolio. Consideration of an annuity would depend on other alternative investments, family and dependent needs, future retirement and income needs, estate and financial planning considerations. Tax treatment of an annuity during the accumulation period when contributing funds and at the time the annuity funds are paid out can have an affect on ones decision as to the purchase of an annuity and to the type of annuity. As with other types of products there are various costs associated with purchasing an annuity.

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