Annuities are complex investments that have many features that may or may not be right for you. Below is a list of some of the benefits to annuity contracts and some points to consider about each.
|
Feature |
Benefit |
Points to Consider |
|---|---|---|
| Tax Benefits | Annuities are retirement investments and, therefore, grow tax deferred. This means that you aren't taxed on any gains that accumulate inside of your annuity contract until you take a withdrawal. Upon withdrawal, interest/gains or any untaxed funds (e.g., IRA) will be taxable. | Because annuities are retirement products, if you withdraw taxable money prior to age 59 1/2, you may be subject to an additional 10 percent penalty from the IRS. Withdrawals from annuity products are taxable as ordinary income to the recipient. |
| Annuitization | Annuities allow you to set up a payment stream for a period of time (called annuitization). This payout stream might be for your life, a set number of years, or a combination. | Annuitization is generally irrevocable, so once the payment stream has started, you cannot change your mind and take a lump sum from your contract. |
| Guaranteed benefits | Most annuity contracts have guaranteed benefits, such as a death benefit or living benefit. Some of these guaranteed benefits are included in the contract while others are optional riders that you sign up for when you buy the product. | Many enhanced benefits require the policyholder to pay more in fees for the benefit. For an enhanced death benefit, for example, you may have to pay an additional 0.5% per year based on your contract value. If you have more than one guaranteed benefit on your policy, these fees can add up quickly. It is important to understand exactly what benefits you are buying and how much they will cost over the life of the contract. |
| Avoids Probate | If you name a beneficiary (other than your estate), the death benefit on your policy will be paid directly to that person or entity and avoid the probate process. Your beneficiary may be able to take a lump sum distribution of the benefit or possibly spread the payments out over years. | Unlike life insurance, annuities are taxable to the beneficiary. Annuity proceeds are taxable as ordinary income, and your beneficiary may have limited options for spreading out the tax liability over multiple years. If you are buying an annuity to pass along a death benefit to your beneficiaries, it is important to find out what options they may have with the account. The options may vary depending upon the type of beneficiary named on the policy (e.g., spouse, trust, children, etc.). |
| Premium Bonuses | Some annuity contracts offer a premium bonus, which is an additional credit to the first year premium, apart from the rate of return. For example, if your policy offers a 5% premium bonus and you invest $100,000, you will receive an additional $5,000 credited to your policy. | Most bonus annuities require that the policy be in force (i.e., open) for a number of years before the bonus is vested (i.e., fully available to you). This period can be up to the length of the contract term, so it is important to understand when you are able to access those funds. In addition, some bonuses are not just credited to the current policy value; you may be required to annuitize your contract to receive the benefit. If you are considering a bonus annuity, ask if there are any limitations on how the bonus is applied to your contract. |
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Rollovers and 1035 Exchanges (also called replacements) |
The current tax code allows annuity owners to transfer their annuities from one product to another, under certain circumstances, without incurring any tax liability. | Liquidating an existing annuity contract and transferring it to a new one should be undertaken with caution. Your original contract could still be subject to surrender charges that would be assessed at the time of transfer and any enhanced benefits will be lost (e.g., a guaranteed death benefit). If you have been paying for additional guaranteed benefits on your old policy, you are losing both the benefit and the fees you paid to have that benefit at the time of the transfer. It is important to understand what you are giving up and to make sure that the new contract is appropriate for you. Bonus annuities are sometimes pitched as a way to “make up” for surrender charges that you are paying for the transfer. As discussed above, bonuses often have strings attached, so it is critical to understand if this bonus is really making up for your losses. Insurance companies selling annuities through insurance agents pay commissions on each sale, so remember that each time an annuity is moved from one product to another, the agent makes money. You should carefully evaluate whether the proposed replacement is really a good idea for you and not rely only on what an agent is telling you. |