In its most general sense, an annuity is an agreement for one person or organization to pay another a stream or series of payments. Usually the term “annuity” relates to a contract between you and a life insurance company, but a charity or a trust can take the place of the insurance company.
There are many categories of annuities. They can be classified by:
Nature of the underlying investment – fixed or variable
Primary purpose – accumulation or pay-out (deferred or immediate)
Nature of pay-out commitment – fixed period, fixed amount, or lifetime
Tax status – qualified or nonqualified
Premium payment arrangement – single premium or flexible premium
An annuity can be classified in several of these categories at once. For example, you might buy a nonqualified single premium deferred variable annuity. For brief definitions of these categories, click here.
In general, annuities have the following attractive features:
Tax deferral on investment earnings
Many investments are taxed year by year, but the investment earnings—capital gains and investment income—in annuities aren’t taxable until you withdraw money. This tax deferral is also true of 401(k)s and IRAs; however, unlike these products, there are no limits on the amount you can put into an annuity. Moreover, the minimum withdrawal requirements for annuities are much more liberal than they are for 401(k)s and IRAs.
Protection from creditors
If you own an immediate annuity (that is, you are receiving money from an insurance company), generally the most that creditors can access is the payments as they’re made, since the money you gave the insurance company now belongs to the company. Some state statutes and court decisions also protect some or all of the payments from those annuities. And your money in tax-favored retirement plans, such as IRAs and 401(k)s, are generally protected, whether invested in an annuity or not.
An array of investment options, including “floors”
Many annuity companies offer a variety of investment options. You can invest in a fixed annuity which would credit a specified interest rate, similar to a bank Certificate of Deposit (CD). If you buy a variable annuity, your money can be invested in stock or bond (or other) mutual funds. In recent years, annuity companies have created various types of “floors” that limit the extent of investment decline from an increasing reference point. For example, the annuity may offer a feature that guarantees your investment will never fall below its value on its most recent policy anniversary.
Tax-free transfers among investment options
In contrast to mutual funds and other investments made with “after-tax money,” with annuities there are no tax consequences if you change how your funds are invested. This can be particularly valuable if you are using a strategy called “rebalancing,” which is recommended by many financial advisors. Under rebalancing, you shift your investments periodically to return them to the proportions that you determine represent the risk/return combination most appropriate for your situation.
Lifetime income
A lifetime immediate annuity converts an investment into a stream of payments that last as long as you do. In concept, the payments come from three “pockets”: Your investment, investment earnings and money from a pool of people in your group who do not live as long as actuarial tables forecast. It’s the pooling that’s unique to annuities, and it’s what enables annuity companies to be able to guarantee you a lifetime income.
Benefits to your heirs
There is a common misconception about annuities that goes like this: if you start an immediate lifetime annuity and die soon after that, the insurance company keeps all of your investment in the annuity. That can happen, but it doesn’t have to. To prevent it, buy a “guaranteed period” with the immediate annuity. A guaranteed period commits the insurance company to continue payments after you die to one or more beneficiaries you designate; the payments continue to the end of the stated guaranteed period—usually 10 or 20 years (measured from when you started receiving the annuity payments). Moreover, annuity benefits that pass to beneficiaries don’t go through probate and aren’t governed by your will.
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2 comments:
On the day my father died his Allstate variable annuity was worth $291,000.00. When it paid out it was only worth $274,000.00. Allstates explanation, "annuity value is determined on the day they receive the death certificate not the day you die". Nice tidy little $17,000.00 profit for Allstate. I have never heard of such nonsense. I wonder what kind of song and dance I would have heard if it had gained 17k before I sent in the death Cert.
Thanks for forwarding me this e-mail to review. It is important for you to note that the product indicated in the e-mail was a "Variable Annuity Product", and that the returns, both positive & negative, for this type of product is usually based on market performance. Simply put, a variable annuity is a tax-deferred investment product that offers various types and kinds of mutual funds to the contract owner to invest their money into. Usually the contract owner(s) will invest in many of the mutual funds offered for diversification purposes to create a "Portfolio". Also, these products offer a death benefit option, with the usual minimum amount being at least equal to the actual amount of money deposited into the product. For example: If Joe invested $100,000.00 in the ABC Variable Annuity and at the time of his death the market performance was negative, making the value only $90,000.00, then the beneficiary will at least receive the $100,000.00 that was originally invested.
I suspect that, at the time of the individuals death, that the beneficiary probably reviewed the last statement on this variable annuity which probably showed the $291,000.00. Then, by the time the death claim was made, that the market was probably down, therefore that is probably why the value was down to $274,000.00. I also suspect that the value received by the beneficiary was probably much greater than the amount invested.
It is also important to note that the $17,000.00 performance loss does not go to any insurance company, it is simply back in the market due to market conditions.
Lastly, I believe that the writer of this post is confusing "Variable Annuity Products" with "Fixed Annuity Products". As you know, Fixed Annuity Products do not go up and down with the market and the returns are usually based on an interest rate return, therefore you would not see a death payment that is less than the last statement amount. Hope this helps.
Best regards,
Patrick Johnson
Allstate Financial Services
Springfield MO
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