Roughly $2.2 trillion in annuity contracts are held by individuals, a hefty amount considering IRAs hold about $9.2 trillion across all types.
Annuity contracts are purchased from insurance companies, who then make regular payments to the buyer. In some cases this is done immediately, although there are cases where it is paid at a specified future date. These payments are made monthly, quarterly, annually, or as a one-time lump sum. Annuity contract holders have the choice to receive money for the rest of their lives, or for a set amount of time.
Money grown in an annuity experiences tax-deferred growth. When this money is withdrawn, it is not taxed as long as it’s going into an annuity, but earnings will still be taxed as regular income. There is no contribution limit for annuities.
Annuities come in two different types: fixed annuities and variable annuities
Fixed annuities offer a guaranteed payout, usually set by dollar amount or by a certain percentage of the assets in the annuity.
On the other hand, variable annuities allow you to allocate premiums to different subaccounts. This allows you to receive potentially higher returns based on the subaccounts, and allows your annuity account value to fluctuate.
Indexed annuities are a special type of variable annuity – during the accumulation period the return rate will be based on an index.
Annuities have contract limitations, charges, and many hidden and additional fees. Most annuities also have a surrender fee that is highest when taking money during the initial years of the contract. Withdrawals and income payments are taxed just like ordinary income – also meaning a 10% federal income tax will apply should a withdrawal be made before age 59 and a half. The guarantees will be based on the issuing company’s claims-paying ability. These are not guaranteed by the FDIC.
Deferred annuity contracts go through two phases – the accumulation phase and the payout phase. During accumulation, the account will grow tax deferred. Once it reaches payout, it will make regular payments to the contract owner.
Case Study: Ian’s Fixed Annuity
Ian is a 52-year-old business owner who used $100,000 to purchase a deferred fixed annuity contract with a 4% guaranteed return. Over the course of 15 years, his contract will accumulate tax deferred. By the time Ian retires, his contract will be worth roughly $180,000.
At this point, the contract will begin making annual payments of $13,250 – only $7,358 of each payment is taxable, while the rest is considered a return of principal. These payments will last for the remainder of Ian’s life, and assuming he lives to 85, will eventually receive nearly $265,000 in payments.
We’re here to help
Annuities can be an effective tool in a carefully organized estate plan. We’re here to demystify annuities and other financial tools so that you can meet your goals throughout your financial lifetime. For more information on how an annuity fits into your plan or for a review of a current annuity, please contact us today for a consultation.