Fixed Annuity Insurance – Things to Consider When Choosing the Best Annuity
Most people have heard of fixed annuities. Often they won’t try them because they’re afraid they’ll lose money. Their fear stems from lack of information on a fixed annuity. A fixed annuity is very similar to a CD at a bank but has additional features that make it far more attractive. Just like a bank, you have guarantees on interest rates.
Fixed annuities are also called immediate or deferred annuities. The difference lies in how you use the product. A person that wants a deferred annuity uses it more like a CD. They don’t take payments from it. The immediate annuity converts to payments over a specific number of years, for a specific amount or payments that you’ll never outlive. Some people like a guarantee that their heirs get any unused principal. That’s available too.
Annuities are for retirement money and receive tax-deferred growth. As with any retirement vehicle from an IRA to a pension plan, if you take the money out of a fixed annuity before age 59 in most cases, you pay a penalty. In this case, it’s 10 percent of the growth. There are exceptions to this rule. Lifetime payments or payments that last to the age of 59 or for at least 5 years if you’re between the ages of 54 to 59 . You or your family also doesn’t have to pay IRS penalties if the owner/annuitant dies or becomes disabled.
Annuities also have penalties imposed by the companies. These are surrender charges. A surrender charge is a percentage that normally decreases the longer you hold the annuity. They often start between ten and four percent with the percentage decreasing over a five to ten year period. However, some contracts may have as high as a fifteen percent surrender charge that never goes away unless you annuitize the payment.
Today many companies offer exemptions from the surrender charge if you only want interest, just like a bank CD, but also allow you to invade the principal for amounts up to ten percent each year. This makes it superior to a CD. If you find yourself in an emergency, you’ll have access to funds without any penalty. It allows you to keep less money in a passbook savings for emergency use.
When you allow the annuity to sit and grow, there’s no taxation or hassle. If you take money, however, there’s two different ways the government taxes the distribution. The way you take the money dictates the type of taxation method. Taking a lump sum gives immediate taxation of all interest. Since the tax is LIFO, last in first out, the IRS considers any money out of the contract to be interest first and then principal.
Immediate annuities have different tax rules. If you use the fixed annuity as a deferred annuity and then annuitize it later, it follows these rules also. Part of the payment each year is principal and part of it is interest, according to the IRS regulations.
The exclusion ratio, the amount you exclude from taxation on payments from fixed annuities, comes from multiplying the expected payment by your life expectancy and dividing the original premium by that number. A 62-year-old person’s life expectancy is 22.5 years. If they receive an annual amount from a fixed annuity of $9000 and live the 22.5 years, they’ll make $202,500 in payments. Simply divide the $100,000 invested by $202,500 to get an exclusion ratio of 49.4 percent. Therefore, you only pay tax on 50.6 percent of the payment.
Because of the favorable tax treatment, high interest rates and secure feeling of never running out of money, many people choose to take payments from the fixed annuity. Some, divide their funds into several different vehicles but use fixed annuities as their base monthly income in addition to social security. They request the insurance company deposit the funds directly into their account just like their social security. By doing this and keeping other investments for appreciation value and emergencies, they always know they’ll have money for monthly needs such as food, shelter and utilities.
If you found this article helpful, by writer John C. Ryan, view more of his thoughts on fixed annuities . On this site we are dedicated to providing you with the latest annuity insurance news, and the best fixed annuity quotes.
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