Annuity Basics

According to Ernest & Young Tax Guide, "an Annuity is a contract you invest in and receive a promise from the insurance company to pay a series of payments for a fixed number of years or over a lifetime."

Types of Common Annuities

Fixed Annuity - an individual gives an insurance company a certain amount of money and they (the insurance company)guarantee a fixed rate of return.

Variable Annuity - invests your money in a portfolio of separate accounts that often mirror mutual, stock, or bond funds (these are not mutual funds, so the returns cannot be looked up in the Wall Street Journal under the mutual fund section).

Equity Indexed Annuity - is an annuity that guarantees a minimum rate of return and allows an individual to participate in the returns based on a index, e.g. S & P 500. However, there may be a cap in regards to how much you can earn in year, such as 10% to 12 % or your level of participation may be 100% or lower in a given year.

Payment Options of Annuities

Immediate Annuity - you give the insurance company money and they convert it into a lifetime or period-certain income (Period certain means the company will pay your beneficiary the remaining years on the contract, in the event of your death during the guaranteed period).

Deferred Annuity - one day you will receive future payments from the insurance company.

Joint Life Annuity - pays you an income until the first death of an annuitant (An annuitant is anyone that the insurance company is required to pay a life income to).

Joint Life and Survivor Annuity - it pays until the death of the second annuitant. On the death of the first annuitant, the second usually receives a reduced amount such as 50%.

Single Premium Annuity - you pay one premium and the insurance company promises to pay you an income in the future (either deferred or immediate annuity).

Installment Premium Annuity - an annuity where your premiums pay for future payments from the insurance company (deferred annuity only).

Other Annuity Facts:

1. 10 % penalty if you take out money before 59 1/2.
2. Death Benefit equals the amount invested - withdraws ( e.g. you invest $100,000 but your account value of the variable annuity is $20,000 at death, due to market loss and there are no withdraws. Your beneficiary will normally be entitled to $100,000 not $20,000 - when it has a death benefit)
3. Earnings can grow on a tax-deferred basis
4. If you are not the spouse of the deceased, you may have five years to dissolve an inherited annuity or one year to turn it into an immediate annuity
5. First U.S. Variable Annuity was by TIAA-CREF.

The variable annuity has its benefits. It offers diversification when limited dollars are available, and can be used to fund many types of retirement plans including the 403B. Generally, a qualified variable annuity has the same early withdraw penalties and exceptions as any other qualified mutual fund plan. The death benefit separates a variable annuity from any other investment.

*Disclaimer: Always consult a tax advisor or financial advisor when making investment decisions.