What is an Annuity?

An annuity is a retirement-planning tool that has two phases: the accumulation phase and the annuitization phase. In the accumulation phase, you give money to an insurance or investment company over a period of time or in a lump sum, and it earns a rate of return. In the annuitization phase, you begin to withdraw regular payments (such as monthly or annually) from your contract until you die.

An annuity has a death benefit, although it is not like one found in a life insurance policy. If you die before you annuitize, your beneficiary will receive either the current value of your annuity or the amount you have paid into it, whichever is greater. For example, if you die when your investments are performing poorly and your account value is less than what you have paid in, your beneficiary would receive the amount you paid in.

Once you begin to receive monthly payments, you no longer have a death benefit on your contract. For example, if you annuitize at age 65 and die at age 67, the insurance company keeps your money in your contract. However, you can buy "term certain" annuities, which guarantee that either you or your beneficiary will receive payments for a certain period of time, such as 10 to 15 years. For example, if you died three years after you began receiving payments from a 10-year term certain annuity, your beneficiary would still receive payments for the next seven years.

The money in your annuity grows tax-deferred, meaning that the money is not taxable until you begin to receive payments from your annuity. Once you receive payments your gains are taxed at your ordinary income tax rate. If you die before you annuitize, your beneficiary pays taxes on the death benefit. In either case, the person who receives the money (the annuity-holder or your beneficiary) is taxed at his or her ordinary income tax rate.

The ideal annuity buyer is 55 or older. Annuities are less attractive to younger investors because there is a 10 percent penalty tax if you withdraw money from your annuity before age 59½ for reasons other than death or disability. However, many people who have already retired and need annuity income right away opt for immediate annuities, which skip the accumulation phase and begin to issue payments as soon as you invest in the contract.

The ideal annuity buyer is a person who has already contributed the maximum amount to their existing tax-deferred retirement plan, such as a 401(k), 403(b) or IRA. That's because you are already building up tax-deferred money in those plans, and the fees associated with those savings vehicles usually are much lower than those of annuities.

Types of Annuities

There are three kinds of annuities and each differ in how the money in your contract is invested.

Fixed annuity
The money you invest earns a fixed rate of interest that is guaranteed by the claims-paying ability of the insurance company. The upside is that there is no market risk involved. The downside is that you will miss out on any gains you could have made if the stock market performs well. When you annuitize, your payments are also fixed.

Variable annuity
Your money is placed in investment options known as sub-accounts, which are similar to mutual funds. Each sub-account has its own degree of risk, ranging from aggressive growth portfolios to bond portfolios. The upside is that you have the opportunity to make substantial gains, depending on the performance of your investment. The downside is that you will lose money if your investments perform poorly. Another downside: It may cost you to switch your money among sub-accounts. When you annuitize, your payments fluctuate depending on the performance of your investments. Some variable annuities allow "fixed annuitization," in which you receive fixed payments. The insurance or investment company recalculates your payments each year based on the performance of your investments.

Equity-indexed annuity
Your money is invested in a fixed account and you may earn additional interest based on the performance of a particular stock index, such as the Standard & Poor's 500 Index, the Dow Jones Industrial Average, the Nasdaq Composite Index, or the Russell 2000 Index. The upside is that you get the opportunity to earn money based on stock performance and the stability of a fixed account. The downside is that you still essentially have a fixed annuity, and the gains you can make in the contract due to the performance of the stock index are fairly small. When you annuitize, your payments are fixed. Early surrender of an equity indexed annuity can incur surrender charges which may reduce or eliminate any return.

Annuities are not right for everyone. They are intended for long term investing, such as for retirement. Withdrawals prior to age 59½ may result in a 10% IRS penalty. Surrender charge may also apply.

Securities and Insurance products offered through LPL Financial and its affiliates. Member FINRA/SIPC.

Mutual Funds, annuities and other investments through LPL Financial are NOT deposits, are NOT insured by the FDIC, NCUSIF or any other regulatory agency, are not obligations of or guaranteed by LBS Financial Credit Union, or any other affiliated entity, are subject to investment risk including loss of principal and are subject to fluctuating rates of return. LPL Financial is not affiliated with LBS Financial Credit Union. Tom Corrado is registered to discuss and transact securities business to residents of the state of CA.


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