Things To Consider When Choosing the Best Fixed Annuities
Fixed annuities work like a CD, but with additional benefits. If you use a fixed annuity as method of savings, you get some additional features you won’t get with any CD. Some of the features of the fixed annuity are attractive but you need to understand the drawbacks too before you make a financial decision.
If you invest in a fixed annuity, you can either use it as a deferred or immediate annuity. While they both use the same fixed annuity, the way you take the money is different. Immediate annuities offer annuitization or periodic payments. You have several options such as fixed payments, a specific number of years for payments, payments for a lifetime or payments for a number of years or lifetime with a guarantee your beneficiary gets any unpaid amount of principal or the balance of the payments if it’s set for a specific time. Clients use the product as a deferred annuity when they don’t want any money right away but want tax-deferred growth.
While the tax-free growth of interest is a real plus over the taxable interest of the CD, there are some precautions you need to take. If you’re under the age of 59 and take any money from your fixed annuity, you’ll find the IRS imposes penalties. An annuity is a retirement vehicle and just like any retirement account, you pay a10 percent penalty on the growth if you take money before 59 . That is, of course, unless you take substantially equal periodic payments that last until that age or at least 5 years. Then the IRS approves it with no penalty.
Annuities also have penalties imposed by the companies. These are surrender charges. A surrender charge is a percentage that normally decreases the longer you hold the annuity. They often start between ten and four percent with the percentage decreasing over a five to ten year period. However, some contracts may have as high as a fifteen percent surrender charge that never goes away unless you annuitize the payment.
There are exceptions to the surrender charge. Many contracts offer the ability to remove funds of as much as ten percent without penalty. This amount may be available each year or once for the life of the contract. Almost every annuity allows you to take the interest penalty free each year and some people use the annuities that way, just as they’d use a CD.
When you allow the annuity to sit and grow, there’s no taxation or hassle. If you take money, however, there’s two different ways the government taxes the distribution. The way you take the money dictates the type of taxation method. Taking a lump sum gives immediate taxation of all interest. Since the tax is LIFO, last in first out, the IRS considers any money out of the contract to be interest first and then principal.
Immediate annuities use a different, favorable set of rules. The good news is that if you decide to annuitize a deferred annuity, you get the favorable tax treatment. The tax law indicates that part of the payment on systematic payment for fixed annuities is principal and part of it is interest. This allows you to spread the taxable growth out over several tax years.
To calculate the amount you pay in taxes each year you use an exclusion ratio. The exclusion ration is how much you exclude from that contract’s income. To find it, you need to know three things; your life expectancy, your payment and the amount you invested. You simply multiply your payment times the number of years for life expectancy. If you receive $800 a month and have a life expectancy of 22 years, you’ll get approximately $211,200 over the lifetime of payments if you collect in full. If your initial investment was $100,000, you divide that number by 211,200 and get an exclusion rate of 47 percent. In this case, you’d only pay taxes on 53 percent of your annual income from the fixed annuity.
People often select fixed annuities because they either love the idea that they’ll never outlive their money, find it a useful tax-planning tool or simply like the high rate and ease of use. Many financial planners suggest that individuals divide their funds into several different vehicles for higher returns and a safer investment strategy. Often seniors fin that a fixed annuity is a great way of establishing a base income in addition to social security or their pension. They know they’ll never run out of money, have a higher payment than an interest payment and can allow other funds to grow at higher rates of return.
John C. Ryan authors about annuity insurance, and advises how to find the best annuity for you. Want to learn more?? Visit us, for more advice on fixed annuities .
