When I first started offering annuities in 1995, they were basically an alternative to certificates of deposits (CD’s). Most were fixed, with a first-year bonus, and people purchased them for tax deferral and growth. After assisting in setting up over $97,000,000 (ninety-seven million) in fixed and fixed index annuities, they are no longer your “Granddad’s Annuity”. Safety is still at the forefront and I continue to take great pride in the fact that none of my clients has ever lost a penny due to market changes.
This guide is designed to educate and simplify the subject of ANNUITIES; thus, the title “Annuities 101”. (This guide is not designed to offer legal, tax or financial advice. It is not geared toward any particular insurance company nor its products. Consult the appropriate legal, tax and financial professionals for this information).
WHAT IS AN ANNUITY?
An annuity is a contract between you and an insurance company. They can only be offered by an insurance company and the contract must have the option of a series of income payments sometime in the future. Most annuities are set up for future retirement income and are not designed to reach short-term financial goals. An annuity is the only financial instrument that can guarantee a paycheck as long as you live. Even though they are offered through insurance companies, they are not life nor health insurance.
WHAT ARE THE TWO PHASES OF AN ANNUITY?
They are the Accumulation period and the Payout period. The accumulation period earns interest that is tax deferred as long as you leave the interest in the annuity. You also earn interest on the interest (compounding). The second phase or payout period is when you start receiving income. You usually have the option of choosing when to start this payout phase.
WHAT ARE THE DIFFERENT TYPES OF ANNUITIES?
There are three types:
3. Fixed index or Equity Indexed.
Fixed annuities guarantee you a certain rate of return for a certain time frame. Many have a first-year bonus. Example: a fixed annuity may offer you a first-year rate of 8% which includes a 5% bonus and 3% for the next 7 years. You know how much your return will be for 8 years.
Variable annuities have risk and fees but they have the highest chance of growth. With this chance of growth comes the risk of losses. There are no guarantees. The premium can be invested in stocks, bonds or other accounts depending upon the risk that you are willing to take. A different type of license is required to sell variable annuities.
Fixed Index annuities offer the best of the other two types without the risk. You earn interest based on an external equity index such as the S&P 500. You are NOT in the market. There are limitations (Caps, Spreads and Participation Rates) that reduce your overall growth. This trade-off is that in the worst-case scenario, you will earn zero interest if the chosen index loses value. You share in part of the gains and none of the losses.
HOW ARE ANNUITIES TAXED?
From a tax standpoint, annuities are either Non-Qualified or Qualified based upon where the funds came from. 1. Non-Qualified uses “after tax dollars”. The principal has already been taxed. Only the interest/gain is taxed when you draw it out. As long as it remains in the annuity, no taxes are due. 2. Qualified uses “pre-tax dollars”. Examples of these would be IRA’s, 401k’s, 403b’s, 457’s, or TSP’s. When withdrawals are made from qualified annuities, the entire amount drawn out is taxed. (There are no tax benefits from placing these accounts in an annuity.) IRS rules require you to start your Required Minimum Distributions (RMD’s) on these when you reach the age of 70 ½.
WHAT HAPPENS TO MY ANNUITY IF I DIE? Annuities do not go through probate as long as you have a named beneficiary. Your family, or named beneficiary, will receive the account value upon death, regardless of the length of time it has been in force. Most annuities allow a lump sum payout while some that have a bonus, may require a 5-year payout to receive the higher value. It is all spelled out in the contract. (Sometimes, a 5-year payout may be better for your beneficiaries from a tax standpoint.) If you have started receiving income from the annuity, your family could continue receiving the income stream until the term agreed upon expires. The only exception is if you choose “life only”, which means that the checks stop when the annuitant dies. Very few people choose this option.
WHAT IF I NEED MONEY OUT OF MY ANNUITY?
Most annuities allow up to 10% free withdrawal each year (after the first year). Some have health provisions written in the contract that allow for early withdrawals: hospital stay, nursing home confinement, assisted living confinement or a terminal illness.
ARE THERE FEES OR CHARGES WITH AN ANNUITY?
Fixed and Fixed Index annuities do not have fees; Variable annuities have fees and charges. The only exception is if you choose to put a “rider” on a fixed index, there would be an annual fee. Only add a rider if it will benefit you and your situation. Never pay for something that you are not going to use. Riders might be added for nursing home protection, guaranteed rate for income, or inflation protection.
WHAT IS MEANT BY ANNUITIZING?
This means that you have chosen to start receiving periodic payments from your annuity, usually monthly. You have a number of options on how long you want the payments to last for you and your family. Do not annuitize unless you need the payments to meet your financial needs. Most annuities, reduce greatly the amount that your contract grows once you annuitize. Most clients, choose to use their 10% free withdrawal option. You do not have to decide whether to annuitize until years from now.
CAN I ADD MONEY TO MY ANNUITY?
Every annuity is different. Some allow additions only in the first year; some for three years, others for five. It is spelled out in the contract.
CAN I GET A BONUS WITH MY ANNUITY?
Some annuities will give you a first-year bonus from 2% up to 15%. Every bonus has restrictions (there are no free lunches). There are usually trade-offs with a bonus (length of contract, lower growth potential, death benefit payout options, etc.) Don’t get blinded by the bonus.
WHAT IS MEANT BY CAPS, SPREADS AND PARTICIPATION RATES?
These restrictions are associated with Fixed Index annuities and you can change your mind on the index options annually. 1. Caps= this is the maximum that you can earn in a specific time frame. Example: if the cap is 5%, you will earn no more than 5% even if the index goes up 8% or 10%. 2. Spreads=this is the percentage that the company gets first from the index gain, you receive the rest. Example: if the spread is 3%, you get everything above 3%. If the index goes up 8%, you would receive 5%. 3. Participation Rate=this is the percentage of the index gain that you receive. Example: if the participation rate is 60% and the S&P goes up 10% in a year, you would get 6% return (60% of 10). Remember that the floor is zero. Your account value can never go down and gains added to your annuity can never be taken away.
WHAT IS MEANT BY SURRENDER CHARGES?
This is the same as early withdrawal charges. Annuities have a stated term such as 9 years. The surrender charge usually reduces each year that the annuity is held in deferral until it goes away. Example: a 9-year annuity may start with a surrender charge of 9% and reduce by 1% every year. This is the charge to draw the funds out early. The surrender charge goes away upon death. It is spelled out in your contract and you know upfront, how much it would cost you to terminate your contract early. Some companies have special health provisions to withdraw the funds early without a penalty. Others have a “bailout option” if the company’s interest rate drops below a certain level, there is no charge.
WHAT ARE THE DISADVANTAGES OF ANNUITIES? There are usually two different “negatives” related to annuities: the length of the surrender period and the restrictions on how much gain can be received. Some people feel as though their money is “tied up” for a certain time frame. You can always get 10% free out after one year. Annuities shouldn’t be set up for short term. They are usually for retirement income. Restrictions or limits on the gains are placed on fixed index annuities to protect you from market downturns. You are trading some of the gains through caps, spreads and participation, for the protection from market corrections.
IS AN ANNUITY RIGHT FOR ME? ASK YOURSELF THESE QUESTIONS:
Do I need these funds for living expenses?
When will I need more retirement income and how much?
What is my age and risk tolerance?
Which is more important? Return ON Principal or Return OF Principal?
Do I have other funds that I can get my hands on if needed?
How important is it to me to leave a legacy for my family?
How can this annuity be used in conjunction with my Social Security?
Am I paying too much in taxes?
Am I better off with my money in the bank, credit union or in a brokerage account?
Which type seems to fit my needs: Fixed…Variable…Fixed Index?
WHAT SHOULD I DO NEXT?
You can set up a meeting with James H. “Brad” Bradford. There is no obligation and everything that will be discussed is strictly confidential. I will be glad to come to your kitchen table and drink a cup of coffee with you. Ask for a free copy of the book that I wrote: “Hang in There Like Hair in a Biscuit.” The key to deciding if an annuity is right for you is to get more information and get educated even more. This is an important decision for your retirement needs. Check up on my background with the following entities:
1. Better Business Bureau of Northwest Florida.
2. National Ethics Association.
3. Alabama Dept. of Insurance, license#40254
4. Florida Dept. of Insurance, license#A028084
5. Georgia Dept. of Insurance, license#110957699
6. Mississippi Dept. of Insurance, license#8841
7. Arkansas Dept. of Insurance, license#1904662.
I have been licensed for over 23 years and led more than 1600 Retirement Workshops with a rating of “Excellent” or “Best” by more than 90% of attendees.
Brad can always be reached at the following:
Email: firstname.lastname@example.org or email@example.com
Phone: cell…205-349-9674 office…850-582-0633
412 Trotters Mill Rd.
Wetumpka, Al. 36093
Book website: hairinabiscuit.com
In 2018, I will be setting up “In Home” workshops for 8 people at a time. Contact me about hosting a meeting for your friends. This is a new concept that I have designed where friends can get their questions answered in a small group setting with light refreshments.
“The Good…The Bad...The Ugly”
By: Brad Bradford