The Best of Annuities

Before defining an annuity, it is important to know that a record number of individuals are purchasing annuities in record amounts. An annuity is a contract between an individual and an insurance company, under which the individual makes a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to this individual beginning immediately or at some future date. An annuity in its basic form is a series of payments (income) made at regular intervals over a period of time.

These periods of time are usually individuals lifetime and or spouses lifetime. An annuity is a series of payments required to be made or received over time at regular intervals. The most common payment intervals are yearly (once a year), semi-annually (twice a year), quarterly (four times a year), and monthly (once a month).

Annuities, first and foremost, are insurance products and, secondarily, savings vehicles. That said, annuities do “make sense for someone who's already maxed out in qualified plans and is looking for a way to defer taxes on additional investments. The term annuity means simply a stream of payments. An annuity contract is an instrument designed to convert a sum of money into a drawn out series of payments so clients can pace their use of income over time. The buyer of an annuity hands over a lump sum or series of premiums to an insurance company, which uses actuarial tables and projected investment returns to repay the account value — plus potential appreciation — over a set period of time. Annuities account for $410 billion or 14% off the total savings amassed by families in the United States.

Annuities and Regulated Markets
Annuities are sold in regulated markets. It is vital that annuities be reasonably priced and that the annuity market be effectively regulated. Until 1850, there was little regulation of the insurance industry in the United States. Several insurance scandals led to pressure for regulation, and in 1850, New Hampshire became the first state to appoint a commissioner of insurance. Many other states followed suit in the next two decades, and in the early 1870s the insurance industry in virtually all states operated under regulatory control.

The primacy of state regulation of insurance markets was confirmed when the U.S. Congress passed the McCarran-Ferguson Act in 1945. State insurance regulations are not uniform, and this can affect the scope of annuity products available to consumers in different places. Some industry people attribute the slow early growth of variable annuities, after their introduction by TIAA in 1952, in part to the requirement that such products receive regulatory approval in each state. Insurance regulation arose historically in part because of the complexity of insurance products and the relative lack of sophistication on the part of many insurance buyers.

Variable annuities are regulated differently than fixed annuities, with insurers maintaining separate asset pools as reserves against variable annuities. This prevents poor returns on the variable annuity portfolio from affecting the capital base for other insurance company products. Variable annuities, because of their investment component, are also regulated in part under the federal securities law. These products are subject to provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. Annuities are a unique financial product that, along with Social Security, employer pensions, your 401(k) plan, IRA and other assets, can enhance your retirement security. Discuss this option with your insurance professional or financial planner when mapping out your retirement strategy.

Options in Annuities
There are generally two types of annuities—fixed and variable. In a fixed annuity, the insurance company guarantees that you will earn a minimum rate of interest during the time that your account is growing. Annuities can also be either deferred or immediate. Deferred annuities are invested over an “accumulation period” of often at least 10 years, giving the premiums time to appreciate.

At some point in the future, the account value is repaid to the client either via a lump sum, via systematic or periodic withdrawals designed to last a given period of time or via lifelong payments. If the purchaser chooses a single life annuity, income will flow for life, even after the account value is depleted. Insurers can afford to do this in the same manner as they can afford to pay life insurance to people who die young — from the pools of premiums paid by those who don't.

Under general defining terms, there are two investing styles of annuities: fixed and variable. The fixed annuity pays a set interest rate during the accumulation phase and a predetermined amount during the annuitization period. Fixed or variable annuities are good for different reasons and for different times in one’s life. Fixed annuities are good for anyone seeking an easy-to-identify stream of income down the line because they have the same basic pros and cons as bonds. They have a predictable income stream but a vulnerability to rising inflation.

It may be true that all annuities come with a price tag. So let’s look at some of the fees and charges that accompany the annuity. Besides fees to the insurer and the administrator, upfront sales and back-end surrender charges often apply. The back-end surrender charges usually start as a 7% penalty for withdrawing money in the first year. But the investor must understand that they decline each year afterward.

It may be that these fees and charges make annuities less desirable to the investor than qualified retirement plans or even investments in taxable mutual funds. Most variable annuities have such high costs built into them that they are generally bad investments so an individual is generally paying 1.5% to 2.5% more in avoidable expenses. Even the annual expense ratio paid to managers of the subaccounts is higher on average than expense ratios on the same mutual fund outside an annuity.

Annuities as A Retirement Planning Tool
Annuities may be defined in many different ways but one very important on is as a retirement tool. An annuity is a retirement planning tool designed to protect against the risk of outliving one's financial resources. Annuities are one of the few financial vehicles that allow money to grow tax deferred. An annuity as a retirement-planning tool is a unique product in that it has two phases: the accumulation phase and the annuitization phase.

The accumulation phase comes first, of course and the individual gives money to an insurance or investment company over a period of time or in a lump sum, and it earns a rate of return. Second, comes the annuitization phase. In the annuitization phase, one begins to withdraw regular payments (monthly or annually) from a contract until he or she dies. Furthermore, an individual has several annuity income options, including the choice to receive either a steady stream of income throughout a lifetime or one lump sum payment if one so chooses to surrender the policy. An annuity is a fixed or variable investment contract, issued by an insurance company, that provides income payments to an annuitant or beneficiary, beginning immediately upon issuance of the annuity (immediate annuity) or at a future date (deferred annuity).

There are many company retirement plans that are annuities paying a regular income to the retiree for his or her lifetime. Now, the original driving force behind the annuities was an income that endured for life. Because of this, the insurance companies could predict the life expectancy of a large group of people with the existing statistics. They can normally do this with a fair degree of accuracy. What this does is enable the pricing of the annuity product accordingly.

One of the differences is that with life insurance, an individual collects only if he or she dies but with a life annuity, the annuitant collects if he or she lives live. So it is the life insurance in reverse. The annuities became popular as a means of growing invested dollars tax deferred and because of the changes in regulations.

Annuities are long-term tax-deferred investments intended for retirement planning. It can be funded in a lump sum or a little at a time, and all capital in an annuity grows and compounds tax-deferred until one begins making withdrawals. Unlike retirement plans, there is no limit as to how much one can invest in his or her annuities. This is different if it is a qualified plan. There are generally no withdrawals until at least age 85 unless it’s a qualified plan.

Copyrighted by Royal Tech Writers & Translator (2009)
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