Annuities 101: Some Basics about a Misunderstood Product

By Jeffrey Long, Allstate Personal Financial Representative

 

If you are tired of the rock and roll of the stock market, your IRA is maxed out, and safety and security have become your investment watchwords, then annuities may be the right financial product for you.

 

What is an annuity? Quite simply, it is a contract between an individual and an insurance company that promises an income stream – now or in the future – for an investment of monies.

 

Some Basics

 

There are two main categories of annuities – fixed and variable. With a fixed annuity, you will get an interest rate set by the insurance company.  With a variable annuity, you can choose among different sub-accounts, which provide a variety of underlying investment options, including stock and bond funds.

 

There is flexibility in how the annuity is structured – either deferred or immediate. A deferred annuity begins payout at a future time, whereas an immediate annuity begins payout immediately or within one year of issuance.  You can also annuitize a deferred annuity.

 

Deferred annuities have two phases – accumulation and pay out, sometimes referred to as distribution. The accumulation phase can be set up either with a lump sum or through a series of deposits over time. Moreover, annuities can be paid out in several ways: lump sum withdrawal, partial withdrawals as needed, or as a regular income stream.

 

Furthermore, unlike other savings plans, there is no government prescribed annual limit on contributions. This aspect may be especially helpful for people who do not have an employer-sponsored retirement plan, those who have maxed out their IRAs and workplace savings plans, and/or anyone getting a late start on retirement savings.

 

An important benefit of annuities relates to taxes. Currently, annuities allow the owner’s money to grow tax-deferred until it is distributed. However, distributions taken prior to annuitization are generally considered to come from the gain in the contract first.  If your contract is annuitized, a portion of each payment will be considered taxable and the remaining portion will be a non-taxable return of your investment in the contract, which is also called the “basis.” Once the investment in the contract is depleted, all remaining payments will be fully taxable. If the contract is tax-qualified, generally, all payments will be fully taxable.  Distributions prior to age 59 ½, may be subject to an additional 10 percent federal tax penalty.

 

Below is an overview of fixed and variable annuities. For more specific information about how annuities are structured and how they can fit into your investment portfolio, please talk to a financial professional.

 

Fixed Annuities – The Less Risky Alternative

 

The most easily understood annuity product is a fixed annuity, which – depending on its structure – can promise you a guaranteed lifetime income, regardless of how long you live. Factors including the amount of money deposited, the payout option chosen, and crediting rates will determine the payment amounts, which may or may not be enough to meet your income needs.

 

The main advantage of this product is its relative safety, which depends on the claims paying ability of the company you buy the annuity from. Your principal (initial contribution) will not diminish over time, unless you withdraw it. It may also provide a reliable (if conservative) rate of return over the life of the contract. These contracts generally offer a choice between various guarantee periods, with one, three, five and six year guarantees being most common.

 

In addition, there are fixed annuity products that can provide investors with a higher rate of return forbearing interest rate risk associated with changing interest rates, if they take withdrawals prior to the end of a guaranteed period. These are called market value adjusted annuities and generally have crediting rate guarantee periods ranging from five to 10 years. Other annuity products tie the crediting rate to external market indices, like the S&P 500 or the 5-year Treasury rate.

 

As you can see, fixed annuities come in many different variations to suit the diverse tastes of individual investors. While fixed annuities are considered the safer annuity product, please remember that fixed annuities are subject to the claims paying ability of the issuing insurance company.

 

An indexed annuity earns interest on the potential upward movement of an index, often one based on a certain basket of equities and in some cases, the treasury interest rate. Indexed annuities also typically feature a minimum interest rate. This rate serves as a “safety valve” by providing growth even when the market performs poorly. Indexed annuities are a popular option for people who want greater growth potential than that offered by a standard fixed annuity but do not want the investment risk of a variable annuity.

 

Variable Annuities – Little Known Benefits

 

If you are willing to take on more risk, then variable annuities may be right for you.

 

While benefits and security are not nearly as straightforward as those for fixed annuities, variable annuities still offer several benefits to investors that traditional equity products may not.

 

You can allocate funds between several investment options called sub-accounts, and reallocate funds periodically among sub-accounts without tax penalties. You may even be able to allocate a portion of your investment to a fixed account option. Also, like fixed annuities, earnings are tax-deferred.

 

Another advantage of this annuity product is that there are no initial sales charges, however, there are surrender and contract charges.  Generally, annuities are no-load investments. This allows more of your money to be invested rather than to pay sales charges.

 

Moreover, deferred variable annuity contracts (fund now-payout later) usually include a death benefit if the accountholder should die during the annuitzation phase of the contract.

 

Variable annuities can also offer minimum accumulation benefits, depending on the product’s features. However, there is a cost associated with this feature.

 

A prospectus is the most important source of information about a variable annuity's investment options. It’s important to keep in mind that variable annuities are designed to be long-term investments and substantial charges may apply if you withdraw your money early.

 

Considering Annuities

 

Is an annuity right for you? The answer may depend on your individual financial situation and savings goals.

 

In any event, do your homework before you invest and ask for the assistance of a financial professional, who can help you match the right product to your needs.

 

Allstate Personal Financial Representative Jeffrey Long can be reached at (203) 855-8444 or by visiting his office at 94 East Avenue in Norwalk, CT. To learn more about annuities and other savings options, log onto Allstate’s Web site at www.allstate.com. 

Variable annuities are long-term investments designed for retirement purposes. A customer should carefully consider the investment objectives, risks, charges and expenses of the investment alternatives before purchasing a contract or investing money. These contracts have limitations and are sold by prospectus only.  The prospectus contains details on the investment alternatives, contract features, the underlying portfolios, fees, charges, expense and other pertinent information.  Contact your financial professional to obtain a prospectus.  Read the prospectus carefully before purchasing a contract or sending money. 

Guarantees are based on the claims paying ability of Allstate Life Insurance Company.  

This material is intended for general consumer educational purposes and is not intended to provide legal, tax or investment advice.  Securities offered by Personal Financial Representatives through Allstate Financial Services, LLC (LSA Securities in LA and PA.) Registered Broker-Dealer. Member FINRA, SIPC.  Main Office: 2920 South 84th Street, Lincoln, NE 68506.  877-525-5727.Life insurance and fixed annuities issued by Allstate Life Insurance Company, Northbrook, IL and Lincoln Benefit Life Company, Lincoln, NE. In New York, Allstate Life Insurance Company of New York.