Saturday, August 7, 2010

17) Annuities: One Size Does NOT Fit All

nnutities can be the most comprehensive and flexible financial product available; they are also one of the most sophisticated.

            Annuities are a contract between an individual and an insurance company.  They are both an insurance product and an investment. They can have insurance benefits, tax benefits, and retirement benefits.

            I’m so tired of hearing financial gurus, like Suze Orman and the Dolans’, talk smack about annuities.  Sure, they can be slightly expensive, but you get what you pay for, and sometimes they’re just what the Dr. ordered.  You just want to know how to use them, but that’s what people like me are for; a money doctor, the Trusted Family Advisor.

            There are two phases to an annuity, the Accumulation Phase (where you put money in and let it grow) and the Annuitization Phase (where, guess what, you take money out).

            When you put money in, you usually can have a choice of one or more fixed interest periods (similar to a CD rate) and/or you might have other investment choices, reminiscent of mutual funds.

            You’re not supposed to take your money out before a certain time or there could be all sorts of fees and penalties.  And in certain circumstances, it may be worth, or necessary, incurring them.  If you’re younger than 59 ½, there could be tax penalties.  (Sounds like an IRA, huh?)  If you own the annuity less than, maybe, 7-10 years, the insurance company might penalize you for early withdrawal (again similar in concept to a bank CD).

            While your money grows, it accrues earnings tax-deferred.  When the money comes out, some day, only the earnings are taxable.

            There are two major ways to withdraw.  The first is to Annuitize.  Annuitization is a steady stream of guaranteed payments.  Most people choose monthly payments, and most people choose a minimum of 10 years of payments, but then for life if they live more than 10 years.  There are all sorts of ‘Settlement Options’.  Each payment is partly your original investment, which comes back tax-free and the remainder is the taxable earnings.  This way, your taxes are stretched out over a long period of time, which is better than IRA distribution (where the entire amount is taxable.)

            Some people like this because it becomes a retirement account that they can’t outlive!  However, it’s important to note that when you annuitize, you give up all rights to your principal in return for the guaranteed income.  This is one reason why insurance company ratings are important; you don’t want them going bankrupt when they hold your retirement money or someone’s inheritance.  (NYS-licensed insurance companies tend to be the safest in the nation.)

            Now, some people want to get their money out before the end of the penalty period.  Some annuity contracts allow withdrawals of the interest and/or a small part of the contract value, which can be great for budget items or emergencies.  Some people want the entire amount, though; maybe they found a better investment.

            If the better investment is another annuity, they can usually roll the existing annuity to the new one without taxes, kind of like an IRA.  But if they’re simply surrendering and getting their original money plus the earnings, then the earnings become taxable.  And there may still be insurance company surrender fees, although there are important exceptions, such as when the annuity was used inside an IRA and the owner has to take out Required Minimum Distributions, or maybe the new annuity is with the same insurance company.

            Some annuities will have guarantees for minimum interest rates or minimum values.  Some insurance companies will put a ‘bonus’ into your annuity for signing up.

            There are three legal parties to the contract from the investor’s side of the table: the Owner (who signs and controls everything), the Annuitant (the person who’s entitled to the payments), and, the Beneficiary.  The owner and the annuitant can be the same person.

            Sometimes the beneficiary collects when the owner dies, sometimes, when the annuitant dies, so this is an important issue.  And, sometimes, there can be a Successor Owner, Annuitant, or Beneficiary, which can keep the contract going.

            Like any beneficiary designation (which functions as ‘Will Substitutes’ bypassing the Probate process, time, publicity, and fees), the beneficiary can usually collect immediately (subject to death certificates, paperwork, ID, and a choice about how to collect).

            So, the annuity can be part of your financial plan addressing death, Estate Planning, and Charitable Giving.

            Annuities can be great for education funding, because they are usually an exempt asset for Financial Aid, and their ownership can be changed to another person to help you qualify for financial aid.  They accrue tax free and they pay out with only part of the payout being taxable,  Also, should the owner wish to keep the money in the child’s name, and even their own, they can prevent control by the child who might wish to use the money on something other than education.  In fact, if the owner agrees, they can do so where other education funding accounts (e.g. Savings Bonds, 529 Plans, and Coverdell IRAs) cannot be used!  Finally, should the owner die, the money should, again, become available for education.

            Annuities can be used for planned giving.  Maybe the owner wants to keep control of the money whether it’s still accruing or if it’s in annuitization.  The corpus of whatever’s left at death can eventually go to charity or a loved one.

            So, depending on your financial planning needs, you’ll need to know the options an annuity can offer.

            In the 1970’s or 1980’s, ‘one size fits all’ pantyhose were introduced.  We see how popular they remain…  Isn’t it nice to have things that fit?

            Generally, there ain’t no absolutes.  You should call us to tailor your annuity.

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