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Annuities FAQ

The Ultimate Guide to Annuities for Retirement

When it comes to annuities, we’ve encountered a wide range of questions over the last 18 years. To help select the right financial path for you, we’ll share the most common conversations we’ve had over the years.

Looking for a personalized consultation? We’re ready to answer all of your questions about annuities to find an option that works for you.

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Q: What is a full surrender of an annuity?

A: A full surrender means that you are cancelling your annuity contract. Once this is done, the insurance company does not have to provide you with any more guarantees.

Q: What is a partial surrender of an annuity?

A partial surrender, also known as withdrawal, means you are taking only some of funds from your annuity policy, not the full amount.  Most annuity carriers allow you to have a surrender free withdrawal of 10% each year.

 

Q: What are surrender charges?

A: Surrender charges are the fees associated with selling all or a part of an annuity back to the insurance company during the surrender period.  Surrender periods are usually 3 to 10 years.

 

Q: Are annuities covered by FDIC?

A: Bank savings accounts or CDs are insured by the FDIC.  Annuities are not protected by any national insurance program. They are protected by each individual state insurance commissioner.

Q: How do I purchase an annuity?

A: To purchase an annuity, you’ll need to complete the following steps:

  1. Consult a financial advisor to evaluate your current and long-term goals.

  2. Select your annuity policy based on the goals you’ve identified. Be sure to familiarize yourself with the full contract terms during this step. Riders may be selected at this stage such as income, death benefit, long term care riders.

  3. Select a reputable annuity provider. This is important because annuities are not backed by the federal government. Look for Big Strong Safe insurance carriers.

  4. Make the necessary payment with cash or money transfer from retirement funds or a brokerage account.

  5. Be aware of the free-look period, which provides the opportunity to reject the annuity and receive a refund during the first 10 to 30 days from the contract start date.

Q: Can you take all your money out of an annuity?

A: Yes, but it recommended that you wait until you are 59 ½ to withdraw from your annuity to avoid surrender fees and penalties. However, if you need a portion of your money, most annuity contracts allow you to freely withdraw around 10% annually without any charges.

Q: Which is better, CD or annuity?

A: There are many differences between CDs and annuities from security and penalties to exemptions. When compared to CDs, one main advantage of annuities is that they offer tax-deferred growth, meaning you won’t have to pay any taxes until the money is withdrawn. If you purchase a CD, the interest you earn on your CD each year will be taxed as ordinary income. 

Q: What does an immediate annuity cost?

A: The cost of a single premium immediate annuity that would pay you $1,000 per month until the end of your life would cost about $185,000. This is based on your age and rate of return the insurance company will give you on your money.  Plus, if you live beyond your life expectancy, your annuity will continue at no additional cost.

Q: How much money do I need to start an annuity?

A: The minimum amount of money needed to invest in an annuity is typically $5,000 or $10,000. With the flexible-premium annuity, the annuity is funded with series of payments or a lump sum. The first payment does not need to be large. The immediate annuity starts payments right after annuity is funded.

Q: Do fee-only financial advisors make money on annuities?

A: Fee-only advisors can charge their clients an hourly rate, a fixed annual retainer, or a percentage of the investment assets they manage for their clients.

Q: What is the primary reason for buying an annuity?

A: The biggest reason to purchase an annuity is to provide guaranteed retirement income for the rest of your life.

Q: Why annuities are a poor investment choice?

A: For some, annuities are not a good choice because the returns are sometimes low, there can be tax disadvantages and the lack of liquidity. Also, to invest in an annuity, you often need to make a lump-sum payment.

Q: What are the four main types of annuities?

A: The four main types of annuities are:

  • Immediate

  • Fixed

  • Fixed Index

  • Variable

To learn more about each option, visit our Annuity Types page.

Q: What are the downsides of annuities with taxes?

A: While you don’t pay taxes on annuities during the growth phase, you will be taxed once you begin taking distributions. You’ll also need to keep in mind that the tax rate on annuities is higher than most other investments. This is because the gains are taxed as ordinary income which is often a higher percentage than long-term capital gains.

Q: What are the other disadvantages of annuities?

A: You might encounter misleading high-yield rates. Insurance companies sometimes promise high-yield rates, when the rates are usually guaranteed for only a year. There will also be fees and penalties for early withdrawal before the age of 59 ½. Along with that, it can be difficult for beneficiaries to access the money after your death.

Q: What is the best age to buy an annuity?

A: While the best age to purchase a deferred annuity is different for each annuity investor, financial planners generally agree that optimal time to invest is between the ages of 45 and 55. Your unique financial objectives should be considered before purchasing any investment product.

Q: Why you should buy annuities?

A: Two of the biggest reasons to buy an annuity are to avoid outliving your money and the guarantees offered. Once you purchase an annuity, you start receiving income payments as of the certain date. Those income payments can go on for the rest of your life, which means you will always have a stream of income. You can also have possible principle guarantees depending on the annuity you choose.

Q: What happens to the money in an annuity when you die?

A: After your death, the money in your annuity can be left to a beneficiary selected in your agreement. Insurance companies will then distribute any remaining payments to beneficiaries in a lump sum or stream of payments.

Q: What is an annuity in simple terms?

A: An annuity is a long-term agreement between you and an insurance company that allows you to accumulate funds on a tax-deferred basis. Later payout will be received in the form of a guaranteed income that you cannot outlive. Usually you can purchase an annuity with at least a 3-10-year surrender charge. 

Q: Is an annuity a good idea?

A: An annuity is a way to supplement your income in retirement. For some people, an annuity is a good option because it provides regular payments for the rest of your life, tax benefits and a potential death benefit. However, there are potential cons for you to keep in mind. The biggest of these is simply the costs associated with certain annuities.

Q: What is a 1035 exchange?

A: The 1035 exchange a section in the tax code that allows for the tax-free exchange of non-qualified funds from one annuity contract to another. For example, if you purchase a non-qualified annuity for $100,000 and 6 years later the annuity value is $150,000 and you are out of your annuity surrender charge, instead of cashing in your annuity and paying the tax on your $50,000 gain, you are able to 1035 your annuity to another annuity contract with out paying any tax at all on your $50,000 gain.

Q: What is the difference between qualified and non-qualified money?

A: A qualified annuity is one where payments into the annuity by the investor are tax deferred, similar to 401(k) plans, SEP IRA, Simple IRA and IRAs.  Money placed into qualified annuities are considered pre-tax contributions and the money will be taxed once the owner starts taking any withdrawals from their annuity.

Non-qualified annuities are funded with post-tax dollars and the withdrawals from the annuities are taxed at ordinary income tax rates, which can be a higher rate than long-term capital gains. 

Most distributions from a non-qualified annuity before age 59 ½ are subject to a 10% penalty and distributions are classified as earnings.

Q: How are annuities taxed?

A: Most annuities are taxed by the IRS with the last in, first out (LIFO) approach to taxation. This means your most recent earnings are assumed to be your first withdrawal, followed by earlier earnings and principle.  

Q: Is there a limit on the amount of non-qualified money that can be placed in an annuity?

A: You can put as much money as you would like into a non-qualified annuity from the IRA standards. However, some insurance companies may have limits to how much money can be put into an annuity.

Q: Are annuities considered a liquid investment?    

       

A: No, most annuities have surrender charges. Surrender charges are the penalty percentage an owner will receive if they surrender, or cancel, their contract before the agreed terms. 

Q: Why do annuities have surrender charges?

A: Annuities are designed for long-term financial goals, such as retirement. Surrender charges act as a deterrent to withdrawing money for short-term needs. Insurance companies want a commitment from you to hold your money to invest it over a long period of time.  

Q: Why should I buy an annuity?

A: People buy annuities because, unlike other investments, they provide guaranteed income for the rest of your life no matter how long you live. An annuity can provide more tax-sheltered ways to save for retirement if you already maxed out your 401(k), SEP IRA, Simple IRA or IRA. Plus, annuities have no contributions limits, which means you can put as much money as you want in an annuity depending on the insurance carrier limits. Since annuities provide guaranteed income later on, you may be able to implement a more aggressive investing strategy with your other assets knowing you have some type of guarantees in your annuity.

Q: How does an annuity work?

A: An annuity works by transferring financial risk from the owner, or the annuitant, to the insurance company. Like many other types of insurance you may purchase throughout your lifetime, you pay the annuity company premiums to take this risk. You can fund an annuity with a lump sum or a series of payments, depending on the type of annuity you select.

Unlike other types of insurance, you don’t pay annuity premiums indefinitely. When you stop paying premiums, the annuity starts paying you immediately or you can defer payments. When this happens, your contract is said to enter the payout phase. This payout phase can go the rest of your life or for a certain period of time. 

Annuity payments can be structured to trigger payments for a fixed number of years to you or your heirs, for your lifetime, until you and your spouse have passed away or a combination of both lifetime income with a guaranteed period certain payout. A life annuity with period certain pays you income for life, but if you die during a specified time frame (the period certain years) the annuity will pay your beneficiary the reminder of your payments for the contractual period you chose at the time of applications .

Life with Social Security, annuity lifetime income streams are based on the recipient’s life expectancy. The younger you are when you start receiving income, the lower income payment will be. The older you are, the higher income payment will be.  

You as the annuitant can control your payout method.  

Q: How can you receive payments from your annuity?

A: Payments from the insurance company can be monthly, quarterly, annual or even lump sum. They can start immediately or you can postpone the payments for years or even decades. The longer the insurance company holds your money, the more money you will receive from them.

Q: What is an immediate annuity?

A: An immediate annuity is done by making a single lump sum payment to the insurance company. Then, it begins paying you income for the rest of your life. You have the freedom to determine your payment schedule.

Q: What is a fixed annuity?

A: Fixed annuities pay a guaranteed minimum rate of return for a fixed period of time. Fixed annuities work much like a certificate of deposit (CD) by guaranteeing a rate over a fixed period. You can purchase fixed annuities for 3-10 years. Unlike CD interest, the interest isn’t taxed on an annuity annually. Instead, the money is allowed to grow tax-deferred until withdrawal. 

Q: What is a variable annuity?

A: Variable annuities are designed to let investors participate in the stock market and still enjoy the tax-deferred, lifetime income benefits of annuities. You have the opportunity for higher returns on your money rather than in a fixed or index annuity, but markets are volatile, so there is also a downside risk as well with a variable annuity. 

Q: What is a fixed index annuity?

A: Fixed index annuities blend the safe returns or fixed annuities with the potential stock market upside of variable annuities. However, the upside rates of return are capped at a certain percentage unlike a variable annuity.

Q: How are annuities taxed?

A: The money invested in an annuity grows tax-deferred, which means you don’t pay taxes on the money while it’s in the annuity.  Like your IRA and 401(k), you only pay taxes on the money when you withdraw it. 

In a qualified annuity, funded with pre-tax dollars, withdrawn funds will be taxed at ordinary income rates. For non-qualified annuities, funded with taxed dollars, you won’t be taxed on the portion of your withdrawal that represents a return of your original principal. In a non-qualified annuity, only your earnings will be taxed.

Q: How is my financial advisor payed on the annuity they recommend to me?

A: Annuities have commissions for your broker that are built into the policy. Commissions can range from 1% to 6% depending on the type of annuity you purchase and the surrender charge of the annuities.  

Q: Can I lose money in an annuity?

A: Whether or not you lose money depends on the type of annuity you invest in. Fixed and index annuity products provide principle guarantees, meaning you will not lose money when you invest in these contracts. However, variable annuities involve you putting your money into the stock market, so the value of your investment changes based on the performance of the investments. 

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Michael G. Romanello, CEP, CLTC

Michael G. Romanello is a registered representative of and offers Securities through Independence Capital Company Inc.  Member FINRA/SIPC. 

5579 Pearl Road, Suit 100 Cleveland, OH 44129

Investment Advisory Services offered through Independence Capital Company Inc. 

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