Annuities

“You get an annuity; you get an annuity, you get an annuity, and in fact… everyone gets an ANNUITY!”

It's not a common phrase you would expect to hear from a Dave Ramsey enthusiast.  And for GOOD REASONS! Annuities are a very complex investment system and require a very in-depth breakdown. However, this article intends to give a 30,000-foot overview. We will start by looking at the common terminology to understand annuities and the pros and cons of the annuity product.    

What is an Annuity?

Let’s start by defining an annuity and some common terminology used with annuities.

Annuity

An investment product, where the insurance company agrees to make payments to the Annuitant; these payments can either be made immediately or in the future

Accumulation Phase

A period of time in which the annuity grows (funds are accumulating)

Annuitization Phase

Payments to the annuitant begin

Annuitant

The individual who opens the annuity with the insurance company

Beneficiary

Persons who are entitled to a death benefit if the terms of the Annuity contract permit 

Common Types

There are several different kinds of annuities as well. With so many available, knowing which one could benefit you can be overwhelming. Below are the most common types of annuities, to name a few.

Immediate Annuity

• The insured person provides a large lump sum, and the Insurance company starts to provide immediate payments to the insured person

Deferred Annuity

• Payments to the insured person start at some future date

• The insured party can either provide an initial large lump sum payment or make periodic payments

Flexible Premium Deferred Annuity

• Insured persons make payments, which they can change the amount they regularly contribute; just like investing, the less you contribute, the less your potential income stream is

Single Premium Deferred Annuity

• Initial Large lump sum payment

  • Commonly purchased with proceeds from a life insurance policy

Fixed Annuity

• Funded with a significant initial contribution

• Insured receives a fixed interest rate over a period of time

Variable Annuity

• Funded with an initial contribution

• Invested into sub-accounts that are tied to either the equity or bond market

• No guarantee of returns

Payment Types

Knowing how the annuity would be paid out is important to be aware of, as there are several different ways to do this.

Pure Life Annuity

• Payments are made to the annuitant throughout their lifetime. 

  • Anyone wishing to provide an asset to their heirs would not use this investment vehicle.

Refund Option

• Annuitants can choose a period of time when their heirs receive a payment proceeding the annuitant’s death if the annuitant dies before the end of the annuity

• The annuitant buys a $100,000 annuity and only collects $75,000 before their death; the balance ($25,000) goes to the annuitant’s heirs

Period of Time Certain Annuity

• The annuitant can choose a length of time where the annuity is guaranteed. However, it will continue throughout the entire lifetime of the annuitant

  • The annuitant chooses a “10-year Period of Time Certain Annuity”, but if the annuitant dies in year 7, the annuitant’s heir will receive payments for 3 years 

  • The annuitant chooses a “10-year Period of Time Certain Annuity”, but if the annuitant dies in year 40, since the annuitant received a monthly payment for all 40 years, the annuitant’s heir will not receive any benefit

Joint and Survivor Annuity

• This annuity will cover two annuitants; typically, these are two spouses, and this option will make payments for both the annuitants' lives 

  • Annuitant buys a Joint Survivor Annuity, and one of the annuitants dies within three years, but the spouse dies 30 years later; the surviving spouse will receive monthly payments for their whole life

• No benefit for heirs

Benefit Rider

This is a benefit an annuitant can purchase, allowing the upside potential of the equity market along with a guaranteed rate of return and principal protection. 

• Cost ranges from .3% - 2% annually

Guaranteed Minimum Accumulation Benefit

• Guarantees for a specified period of time an investor’s contract will be at a minimum amount of invested regardless of performance

  • Has principal protection with upside potential

    • Funds are invested in sub-accounts

Guaranteed Minimum Income Benefit

• Guarantees annuitant a minimum amount of income during their lifetime regardless of the investment performance

  • The minimum monthly amount is based on the annuitant’s initial investment

• The annuitant must wait for a specified period of time before annuitization

Guaranteed Minimum Withdrawal Benefit

• Guarantees a percentage, usually 5%-7%, of the amount invested can be withdrawn annually until the entire amount is recovered

  • Principal protection

Guaranteed Lifetime Income Benefit

• Guarantees a certain percentage, usually 2-8%, of the original investment can be withdrawn each year as long as the annuitant lives

• Percent is usually based on age, with young individuals receiving a lower percentage 

Taxation of Annuities

As with everything in life, one must consider the tax associated with an annuity.

• Growth of the investment is tax deferred.  Then, when the annuitant elects to start distributions, growth is taxed at Ordinary income. 

• If the annuitant outlives the original benefit of the annuity, all payments following that point are taxed at Ordinary income. 

  • The annuitant purchases $100,000 annuity.  He receives $2,000 a month.  Of that $2,000, $833 is principal of his original $100,000 and the $1,167 is interest.  After 10 years, he has received the $100,000 that he contributed.  100% of distributions following this point will be taxed at Ordinary Income.

As mentioned at the beginning of this article, annuities are complicated to understand; in fact, many people within the financial community don’t fully understand them.  This information will help clarify this complex product in future articles. 

At Whitaker Myers Wealth Managers, we have a team of financial advisors available to help answer questions and create financial plans to help try and reach your financial goals. If you don't have an advisor, reach out to one of our team members today!