Annuities
Annuity Basics
What is an Annuity?
An annuity is a contract between you and an issuer whereby you agree to give the issuer principal and in return the issuer guarantees you fixed payments over time. While annuities are not insurance policies, they are issued by insurance companies.
An annuity is similar to a retirement plan in that you can fund it in a lump sum or a little at a time, and all capital in an annuity grows and compounds tax-deferred until you begin making withdrawals. Unlike retirement plans, however, there is no limit as to how much you can invest in annuities!
The large number of annuity products on the market today can make selecting the most suitable annuity a confusing process. But in fact, there are only a handful of different types of annuities. When selecting an annuity you will be presented with essentially three choices:
Timing of Payout:
Immediate or deferred. In an immediate annuity, the investor begins to receive payments immediately upon investing. This is for investors who need immediate income from their annuity. In a deferred annuity, the investor receives payments starting at some later date, usually at retirement.
Investment Type (fixed):
Fixed annuities are invested primarily in government securities and high-grade corporate bonds. They offer a guaranteed rate, typically over a period of one to ten years.
Liquidity Options:
Most annuities allow you to withdraw either your interest earnings or up to 15% per year without a penalty (although any withdrawal from an annuity may be subject to taxes and a 10% federal penalty if taken prior to 59 & 1/2 years of age). Most annuities have a surrender charge -- a penalty for making an early withdrawal above the free withdrawal amount. Typically this surrender charge decreases over a seven-year period. Some annuities with surrender charges reward the investor by offering a bonus: the insurance company adds on average 3% to 5% to the amount of your principal. Bonus annuities typically have slightly longer surrender periods, and some charge a slightly higher fee than they charge for their standard annuity. For investors who may need spur-of-the-moment access to their money, there are also annuities without any surrender charges -- these annuities do not offer bonuses, and may also charge a slightly higher fee than the standard annuity, in exchange for 100% access to your money.
Is an Annuity Right for Me?
If you have fully funded or plan to fully fund your IRA, 401 (k), or 403(b) for the year and have additional funds to invest, where will you put the money? Mutual funds? Bonds? Annuities? All of these options are likely present in a well-rounded, well-managed, diversified portfolio. Read on to learn about some important advantages of annuities that can make them an excellent complement to a well-rounded portfolio. The annuity is a place to invest an unlimited amount of money without paying any current taxes until you start to take money out. You can also use an annuity as a funding vehicle for an IRA, Roth IRA, 403b, SEP IRA, or other retirement plan, if suitable.
Invest Unlimited Funds, Tax Deferred
An annuity is similar to a retirement plan in that they both have the advantage of tax-deferred compounding until withdrawn. However, there is no limit as to how much you can invest in an annuity or annuities.
Features & Benefits:
There is no qualifying of any kind with an annuity, and so long as you are not receiving payments (deferral phase only), there is no IRS reporting of any kind (no 1099 or tax bill). An additional benefit of an annuity is that they are not attachable by most creditors and they avoid probate in all 50 states.
Additionally, many annuities offer features and benefits that are not found in other investments (such as mutual funds). The most popular include Death Benefits and Living Benefits.
What are the Different Types of Annuities?
The seemingly large number of annuity products on the market today can make understanding them difficult. In reality, there are only a handful of different types of annuities, and we will help you find the best types to suit your needs. First, let’s discuss the three primary considerations when thinking about annuities:
Timing of Payout — Immediate or Deferred:
The first thing to determine is if you need an immediate or deferred annuity. Read on to learn the difference.
Immediate Annuities
In an immediate annuity, the investor begins to receive payments immediately upon investing. This option is for investors that need immediate income from their annuity. When you purchase an immediate annuity you can choose between payments for a certain period of time (typically five to twenty years - “period certain”), payments for the rest of your life and/or your spouse’s life, or any combination of the two. You can even choose between a fixed payment that doesn’t vary or a variable payment that is based on market performance.
Deferred Annuities
In a deferred annuity, you typically receive payments starting at some future date, usually at retirement. However, most deferred annuities allow for systematic withdrawal payments beginning thirty days after the purchase of your annuity, up to 10% per year, in most cases. With a deferred annuity you can invest either a lump sum all at once, or make periodic payments, either fixed or variable. Those funds grow tax-deferred until you’re ready to begin receiving payments. Deferred annuities make up a large majority of all annuity sales in the United States, and are the type of annuity that are generally recommended if you do not need immediate income from your annuity.
Investment Types — Fixed or Variable:
Fixed Annuities
Fixed annuities are invested primarily in government securities and high-grade corporate bonds. They offer a guaranteed rate of return, typically over a period of one to fifteen years. There are two basic types of fixed annuities: the Guaranteed Return Annuities (GRA) is a fixed annuity that offers a guarantee that you can never receive less than 100% of your investment — no penalties or fluctuations in the interest rate market can impact your principal should you surrender. The Market Value Adjustment annuity (MVA) works much like the GRA, but there is no guarantee of your principal if rates rise and you surrender your contract. MVAs work like a bond and often pay more than a GRA due to the increased short-term risk of rising rates. It is important to note that, unlike a variable annuity, where your funds are held separately from the insurance company, with a fixed annuity your assets are part of the general accounts of the insurer, and are subject to the claims-paying ability of the issuing company.
Variable Annuities
Variable annuities are linked to the stock market and provide investors with a higher rate of potential return, although your principal and earnings can be at risk and decrease in value. At the Arizona Insurance Exchange, we no longer offer these type of annuities, as we decided to ONLY work with annuity products that can GUARANTEE your investment can NOT decrease due to stock market performance. This is why we are considered to be "Safe Money Investment Advisors."
Liquidity Options:
Finally, you will need to determine which liquidity option best suits your needs: those with or without withdrawal penalties.
Annuities with Withdrawal Penalties
“No-surrender” annuities allow you to withdraw either your interest earnings or up to 15% per year without a penalty (although any withdrawal from an annuity may be subject to taxes and a 10% federal penalty if taken prior to 59 & 1/2 years of age). Beyond that, most annuities have a surrender charge - a penalty for making an early withdrawal above the free withdrawal amount. Typically this surrender charge decreases over a seven to ten year period.
Why would you choose an annuity with a withdrawal penalty? Well, some annuities with surrender charges reward the investor by offering a “bonus”: the insurance company adds on average 3% to 5% to the amount of your principal. For example, if you invest $10,000 in a bonus annuity the insurance company will add $300 to $500 to your annuity immediately. The trade-off is that with a bonus annuity the surrender period is usually longer (eight to nine years in most cases versus the typical seven-year surrender). Be aware, some insurance companies charge higher fees on their bonus annuities, as compared with their standard products. Be certain to compare the annual fees of a bonus annuity to the standard or traditional (no-bonus with 7 years of surrender) annuity. Sometimes the company will raise their fees to pay for the bonus.
Annuities without Withdrawal Penalties
For investors who may need spur-of-the-moment access to their money, there are annuities without surrender charges (no-surrender or level load annuities) — these annuities have no penalty or charge for early withdrawal. With that being said, even with a no-surrender annuity, investors under the age of 59 & 1/2 are subject to a 10% federal excise tax as well as ordinary income taxes on any gains. You can avoid any taxes or penalties, however, by making a 1035 Tax-Free Exchange to another annuity, regardless of age. No-surrender annuities do not come with bonuses, and some companies charge higher fees for their no-surrender charge products.
IMPORTANT DISCLAIMER: This information is not intended to provide legal or tax advice. Before making any decisions related to the rollover of a qualified account into an annuity, you are strongly advised to consult with proper legal or tax professionals to determine the tax consequences in your financial plan.
Purchasing an annuity within a retirement plan that provides tax deferral under sections of the Internal Revenue Code results in no additional tax benefit. An annuity should be used to fund a qualified plan based upon the annuity’s features other than tax deferral. All annuity features, risks, limitations, and costs should be considered prior to purchasing an annuity within a tax-qualified retirement plan.
Bonus annuities may include annuitization requirements, longer annuitization or surrender charge periods, higher surrender charges, lower interest rates, lower caps, higher spreads, or other restrictions not included in annuities that don't have a premium bonus feature.
Any distributions are subject to ordinary income tax and, if taken prior to age 59½, a 10% federal additional tax.
• Not FDIC insured • May lose value • No bank or credit union guarantee • Not a deposit • Not insured by any federal government agency or NCUA/NCUSIF • Product and feature availability may vary by state and broker/dealer.
Rollovers & Transfers
The following is a list of common questions that we are asked:
Q: Is it possible to rollover my retirement savings, such as my 401k, 403(b), pension or IRA accounts into an annuity without paying taxes?
A: Yes, you can rollover your IRA, 401(k), 403(b), or lump sum pension payment into an annuity tax-free. Annuities funded with an IRA or 401(k) 403(b), pension or IRA rollover are "qualified" plans, enabling an insurance company to create an "IRA annuity", into which you can deposit your retirement funds directly. Additionally, you can have your employer roll over your 401(k) funds into an annuity without withholding any taxes since no mandatory withholding requirements pertain to funds directly transferred into an annuity by an employer.
Q: If I decide to rollover my IRA, 401(k) 403(b), or lump sum pension payment into an annuity, will I be hit with a distribution tax?
A: NO. The reason you're permitted to roll over these payments into an annuity tax-free is because when you buy an annuity with IRA or 401k money, the first thing the insurance company does is create an IRA holding account to receive your transferred funds. So really, buying an annuity with IRA money is the same as moving your money from its current IRA or 401k trustee to another IRA trustee. This kind of transaction is considered a "direct transfer" or a "direct rollover", which is tax-free. You will owe taxes on the monthly income you receive, but not on the transfer
Q: How can I find and purchase an IRA annuity?
A: Locating and purchasing an IRA or 401k annuity is simple. Review the information and contact us with all of your questions. We'll help you understand and choose your best option and then complete all of the necessary paperwork. When the insurance company receives your application, it begins the rollover process by sending your signed transfer authorization to your current IRA/401k custodian. After a few days, they will send the premium amount to the insurance company. That completes the transfer and your contract is issued and sent to you. As your agent, we walk you through every step of the process. This services is provided free of charge.
Q: Can I "lock in" an IRA annuity rate before the insurance company receives my distribution?
A: It is possible to get a ‘hold rate’ from many insurance companies. Usually, the quoted rate is maintained for several months (typically one to three), while the cash transfer takes place. "Rate hold" periods typically begin once the insurance company is in receipt of all required forms, fully completed.
Q: My money is currently in a 401(k) account. How do I roll it over to an annuity?
A: This depends on your employer's procedures for issuing such checks. Best to contact your Human Resources ("HR") department and ask them. They may send you a distribution request form to fill out. Once that's processed, you'll receive a check made payable to the insurance company for your benefit. This type of check is usually sent to the employee's home address. Since the check is made payable to the insurance company, it's still considered a direct rollover and tax-free. Just send the check to the insurance company with a note explaining these are your funds to pay for the annuity you previously applied for. Around May 15th of the following year, you'll get a Form 5498 from the insurance company confirming the amount on the check was invested in your IRA annuity. Some employers accept insurance company paperwork and will cut a check that is mailed directly to them.
Q: The lump sum pension distribution check I received from my employer is made out to me rather than to the insurance company. Will I still be able to avoid taxation on the distribution?
A: YES. To avoid taxation on your distribution, you will need to roll over the funds into a 401(k) annuity within 60 days. If your distribution is not settled into an annuity within this time period, you will owe taxes on the distribution. To expedite this process, check with your insurance company to see if it is one of the many that will accept a check made out to you but endorsed to it.
Q: I am under age 59 1/2. What tax penalties will apply to me?
A: If you are thinking of making withdrawals from your IRA or 401(k), but you are not yet age 59 ½, you can avoid the 10% federal penalty tax by transferring your IRA or 401(k) into an immediate annuity with a "life contingent" payment option. If you receive the income periodically over your lifetime you may avoid the 10% penalty tax on the money you receive. Remember, that you must choose an annuity which will pay you over the course of your (or your and your spouse's) lifetime(s) and not an annuity which only makes payments for a limited period or term certain (for a specified number of years). You can read about this exemption from the penalty tax in Publication 590 on the IRS website. One of the exceptions is the “Annuity” rule, which says: "You can receive distributions from your traditional IRA that are part of a series of substantially equal payments over your life (or your life expectancy), or over the lives (or the joint life expectancies) of you and your beneficiary, without having to pay the 10% additional tax, even if you receive such distributions before you are age 59½... There are two other IRS-approved distribution methods that you can use. They are generally referred to as the fixed amortization method and the fixed annuitization method." An immediate life annuity calculates its payments based on the fixed annuitization method, and, thus, satisfies the penalty exception rule.
Q: Do you provide assistance with IRA or 401k rollovers?
A: ABSOLUTELY! Since 1989, Ken Kaufman, owner of The Arizona Insurance Exchange, has helped his clients rollover their 401(k), 403(b), pension, and IRA holders rollover their lump sum payments into an annuity, without the need to pay taxes. This is a simple process with the right help, and we are here to answer your questions concerning rollovers and other options with expert advice.
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Please reach out to us using the links below so that we may provide you with a no-cost, no-obligation review of your current portfolio. We look forward to assisting you with your insurance, annuity, and retirement needs.