There are a lot of myths about annuities. With so many types to choose from, figuring what is factual and what isn't about them can be a challenge. To help you understand how annuities work, here are six of the most common misnomers about them.
Although annuities share many common attributes, each annuity type has its own set of rules. In general, an annuity is a contract between you and an insurance company in which you make a lump sum payment or series of payments and, in return, you receive a regular income stream at some point in the future. There are a range of options, but typically they fall into two categories – an immediate annuity and a deferred annuity. An immediate annuity allows you to make a lump-sum deposit and immediately start drawing income. With a deferred annuity, you give an insurance company premium and the company provides options to allow for an income stream when elected. Typically, you’d not start getting payments until years down the road.
Many annuities give you the option to withdraw a portion of the contract without a penalty. Some annuities may require a waiting period before you can access the full value. You may be subject to fees and penalties for an early withdrawal, but many insurance companies allow you to take up to 10% of the accumulation value per year without paying fees.
Most annuity types have no maintenance or annual fees. Those that do will have varying fees depending on the type of annuity and any additional benefits it may provide. Annuities can offer valuable features that aren’t typical of other retirement options, like tax deferral, income guarantees, guaranteed minimum values or even a guaranteed minimum death benefit. Your annuity contract should be transparent about costs. Make sure you understand any fees associated with the annuity and the benefits it can offer, then weigh those against other products.
If you don't want the insurance company to keep your contract value when you die, you can choose an annuity payout option that allows for that. Everything the annuity can and cannot do should be written in your contact. Many people correctly understand that an insurance company will keep the remaining value if they have a "life-only" payment option within an annuity contract, but life-only is just one of many payment options you can choose from for an annuity contract.
If you want to help ensure your beneficiaries receive your remaining annuity value when you die, you can choose an annuity payment option with a refund feature. In general, this type of annuity payment will be lower than a “life-only” payment, but it ensures any balance that remains between the sum of the payments and the account value is paid to your beneficiaries. Everything the annuity can and cannot do should be written in your contract.
Annuities can be excellent tools for accumulation and income, no matter your age. Many young workers are using annuities as a tax-deferred way to save for their future. Of course, no two situations are the same. It’s important to seek tax advice from a qualified tax professional when purchasing an annuity to understand any withdrawal penalties that may apply.
Interest credited on any annuity will compound on a tax-deferred basis until you begin taking out funds. Over time, you may have the potential to build more retirement income than you would have been able to had your earnings been taxed as income. While IRAs and 401(k)s also offer tax deferral, those contributions typically have a yearly cap. Fixed annuities commonly have no annual IRS contribution limits. Fixed annuities are long-term, tax-deferred products and can be a valuable option if you are looking to grow your retirement.
Fixed index annuities are not a direct investment in the stock market. They are long term insurance products with guarantees backed by the issuing company. They provide the potential for interest to be credited based in part on the performance of specific indices, without the risk of loss of premium due to market downturns or fluctuation. Although fixed index annuities guarantee no loss of premium due to market downturns, deductions from your accumulation value for additional optional benefit riders or strategy fees associated with allocations to enhanced crediting methods could exceed interest credited to the accumulation value, which would result in loss of premium. They may not be appropriate for all clients. Interest credits to a fixed index annuity will not mirror the actual performance of the relevant index.
"Income” refers to guaranteed payment of lifetime payment amounts (“LPAs”). It does not refer to interest credited to the contract. Consult with your own tax professional regarding tax treatment of LPAs, which will vary according to individual circumstances.
Withdrawals taken in excess on the penalty free withdrawal allowed during the surrender charge period will be subject to surrender charges, and possibly a market value adjustment. Withdrawals taken prior to age 59 ½ may be subject to IRS penalties.
Under current law, annuities grow tax deferred. An annuity is not required for tax deferral in qualified plans. annuities may be subject to taxation during the income or withdrawal phase. Neither North American, nor any agents acting on its behalf, should be viewed as providing legal, tax or investment advice. Rely on your own qualified adviser.