Annuity FAQ

Q: How do I calculate the present value of an annuity?

A: To calculate the present value of an annuity, multiply the payout amount by the number of payouts by the interest rate per payout.

Q: How do I calculate the future value of an annuity?

A: To calculate the future value of an annuity, multiply the initial principal used to purchase the annuity by the monthly contribution by the number of years to the payout by the annual yield.

Q: Is there a lower or upper age limit to buying an annuity?

A: While there are usually no strict lower limits, the typical upper limit set by insurance companies is 95. Annuities are not recommended for those under 40. The average age of first-time annuity buyers is 50.

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Q: How is annuity income taxed?

A: A lump-sum distribution from an annuity is taxed at ordinary income rates. If the contract is annuitized, meaning that distributions are made each month, quarter, or year, the portion of the distribution that represents earnings is taxed as income. In all cases, remember that only income is taxed, never principle.

Q: What are some things to watch out for when buying annuities?

A: First, the money used to purchase an annuity is not returned except through distributions. Second, annuities typically early withdrawal fees that last for 3-7 years, so makes sure you don't need the money you invest any time soon. Third, annuities can lose value. Fourth, annuities are not FDIC insured.

Q: Who is a good candidate for buying an annuity?

A: Those in their 50s and 60s looking to save additional tax-deferred money for retirement are often the best candidates for annuities. Annuities are also a great choice if you have a large savings at retirement that you wish to prolong even further or turn into a guaranteed life-long income.

Q: How do annuities compare to other fixed income vehicles like CDs, bonds, and money market accounts?

A: Fixed annuities offer a guaranteed rate of return and payout amount for a set period of time or for life. Therefore, regardless of the purchase amount, stock market fluctuations, or life expectancy, the owner will receive a payout. This is not the case with CDs and money market accounts, which are savings vehicles, not income producers. Bonds offer income, but can lose value or be called by the issuer. Fixed annuities typically offer a higher rate of return than CDs, US bonds, or money market accounts. Investment risk in fixed annuities is also comparably low.

Q: Why would someone get an annuity?

A: The majority of people who purchase an annuity do so for guaranteed retirement income, to transfer the risk of outliving their retirement savings, or for the tax advantages. Annuities are sometimes referred to as personal pensions.

Q: What's the difference between an annuity and a permanent life insurance policy?

A: While both an annuity and a permanent life insurance policy offer the potential for an increase in the investment, an annuity does not always pay a death benefit to a beneficiary. Annuities that do have a death benefit do not pay it tax-free. Generally, annuities are designed to provide retirement income while life insurance is designed to offset a family's exposure to loss income.

Q: How many annuities can I own?

A: There is no limit on the number of annuities you can own.

Q: an I open an annuity for a family member, like an elderly parent or spouse?

A: Yes, you can purchase an annuity for another person.

Q: What's the difference between mutual funds and annuities?

A: Mutual funds are securities that invest in stocks, bonds, U.S. Treasuries, or commodities. Annuities are contracts between an individual and an insurance company for a certain payout or yield over a given period of time.

Q: What is the difference between an immediate and a deferred annuity?

A: An immediate annuity begins payouts within 12 months of the purchase date. A deferred annuity typically begins payouts after several years, if not decades, later. An immediate annuity is like a CD while a deferred annuity is like a retirement savings account.

Q: How is a variable annuity different than a 401k or IRA?

A: Some companies offer an annuity option as one of the investment options of a 401(k) but most do not. With a standard annuity, contributions are not made with pre-tax dollars as they are with 401(k)s and IRAs. Variable annuities also typically offer additional features like death benefits, disability benefits, and options for life-long income.

Q: Do all annuities have surrender charges?

A: No. Some annuities are sold without surrender charges.

Q: What are the most common annuity contract riders or options?

A: The most common annuity contract rider is a joint option, in which a husband and wife are joint owners. Other popular riders include a cost of living adjustment (COLA) and the lifetime income option.

Q: Are annuities FDIC insured?

A: No, annuities are not FDIC insured. Annuities are insured at the state level, usually up to $100,000, although each state has sets its own limits.

Q: Which government organizations regulate annuities?

A: Your state's department of insurance regulates all annuities sold within the state. In addition, the Securities and Exchange Commission (SEC), National Association of Securities Dealers regulates variable annuities.

Q: Can I lose principal in an annuity?

A: Yes, you can lose principal with an indexed or variable annuity. You can also lose principal.

Q: Are annuities tax-efficient savings vehicles?

A: All annuities are tax-efficient saving vehicles because they grow tax-deferred, although they are not as tax efficient as an IRA or 401k because your income is eventually taxed at ordinary income rates, not the lower capital gains rate.

Q: Why shouldn't I open an annuity in my 20's or 30's?

A: Younger investors have more risk tolerance and should be investing in equities, mutual funds, and bonds to grow their retirement nestegg. Annuities returns are too low for young investors but ideal for older investors looking for a stable source of retirement income. Annuities are also subject to the early withdrawal IRS penalty so you want to be closer to retirement age to avoid incurring this cost.

Q: What are the downsides of buying an annuity?

A: The risk of loss of principal and the fact that once the annuity is purchased your money cannot be returned are two major downsides of buying an annuity. Commission fees on annuities can also be high.

Q: What are the advantages of buying annuities vs investing in mutual funds?

A: Annuities offer guaranteed income regardless of market conditions. They also grow tax-deferred even if they are not part of a tax-qualified account.

Q: If annuities are supposed to provide lifetime income, how come annuity contracts have fixed terms?

A: The fixed amount that is paid each year is often adjusted based on current interest rates. And, most insurance companies offer a fixed rate of return that the payouts will not fall below. To ensure that distributions keep pace with inflation, consider an annuity with a cost of living adjustment.

Q: What's the difference between a fixed annuity and a CD-type annuity?

A: Actually, a CD-type annuity is a fixed-rate annuity. But a fixed-rate annuity only guarantees the rate for a portion of the term, whereas a CD-type annuity guarantees the rate for the entire term.

Q: What effect do high or low interest rates have on annuities?

A: Fixed annuity interest rates correlate to national interest rates when you sign the contract, so it's generally better to buy a fixed annuity when interest rates are high. Even though fixed-rate annuities generally lock in a pre-defined interest rate, this lock doesn't always work in your favor. If interest rates rise, you incur the opportunity cost of not earning more with another investment. Further, the amount of interest paid might not keep pace with inflation.

Q: What is the best indexed annuity crediting method?

A: Of the four methods – annual reset, point-to-point, high water mark, and averaging – most people will probably do better with averaging. The value of the index is taken at different points during the year and averaged to allow for a smoothing of both increases and decreases. Each crediting method is usually better than another under certain market conditions, making it difficult to pick an all-around "best".

Q: Why are fixed annuity yields generally higher than CDs or bonds?

A: In general, fixed annuity yields are higher than CDs and bonds because the investor must commit his or her money to specific term. A premium is paid for incurring this time risk.

Q: How do annuities work?

A: In exchange for purchasing an annuity, an investor is usually guaranteed to receive something in return. It can either be a fixed rate of return or a fixed payment.

Q: Do beneficiaries have to pay taxes on non-qualified fixed annuities?

A: Yes. If you inherit a non-qualified annuity, you will have to pay taxes.

Q: What will happen to my annuity if the issuing company goes bankrupt?

A: Before you purchase an annuity, find out the maximum amount that is guaranteed by your state's guaranty association or guarantee fund. This is the amount that will be protected if the insurance company becomes insolvent.

Q: Are funds inside an annuity subject to lien and seizure?

A: Under most circumstances they are not, which is why annuities are sometimes used as shelters from litigation.

Q: What happens to money inside an annuity when the annuity owner dies?

A: This depends on how the annuity contract is set up. With some annuities the owner relinquishes the remaining money to the insurance company. With other annuities, the owner's spouse will receive a full or sometimes partial distribution. Money inside an annuity passed to a beneficiary does not benefit from the "step up" rule like other assets.

Q: Which annuities are the safest and which are the riskiest?

A: It depends on how you define safety and risk. If by safety you mean which annuities will pay a guaranteed amount of income each month regardless of market conditions, then fixed annuities are the safest. And since variable annuities can lose principal, they are often considered to be the riskiest.

Q: What are the downsides of indexed annuities?

A: Only a certain percentage of the account will participate in the earnings. The full increase in the index might not be allowed and fees can generally be higher than investing in an ETF or mutual fund, although the downside protection usually offered by indexed annuities does not exist with these alternatives.

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