Understanding Annuities

annuity tree

There are strengths and weaknesses with each financial product you select. The key in developing your lifelong financial strategy is to realize this and to plan accordingly. Many of us hear the term "annuity" but don't really understand what this means or what type of a financial tool it is.

What is an annuity?
The term "annuity" simply refers to a series of payments over time.

Some people establish a private annuity which is a contract for income between two people. This is not what we are discussing here.


Commercial annuities are financial products that provide you with guaranteed income over a period of time. When you purchase an annuity, you sign a contract with the issuing insurance company. In return for your payment, the insurance company agrees to provide either a regular stream of income or a lump sum pay-out at some future time. The maturity date of the annuity is set in the original contract with the insurance company.

 With respect to taxation, annuities are either qualified (contributions deducted from income) or non-qualified (after-tax contributions).

What types of annuities are out there?
There are many different types of annuities that you can purchase. Every annuity has two basic properties:

  1. Whether the payout is immediate or deferred, and
  2. Whether the earnings are fixed (guaranteed), variable (i.e., linked to an investment securities) product or indexed (a type of fixed annuity).

Let's take a closer look at each of these properties.

Immediate versus deferred annuities
Immediate: An annuity with immediate payout begins payments to the investor owner immediately after it is purchased. Usually, with an immediate annuity, payments must start within one year of purchase.

Deferred: A deferred payout means that the owner will receive payments at some later date.
Fixed, variable and index annuities

Fixed:  Fixed annuities provide a guarantee of principal and a guaranteed minimum interest rate for a period of time. These are insurance products, not security products.

Variable:  Variable annuities are a securities product. The main different between fixed and variable annuities is that in the variable annuity the owner bears the investment risk. The owner can lose the initial principal.

Fixed Index:  Fixed index annuities are separate and distinct from variable annuities. Fixed index annuities are generally a type of fixed annuity. Both fixed and index annuities do not subject the principal and credited interest to risk of loss. The main difference between the fixed and fixed index products is the way the interest is credited above the minimum guarantee.

Major components of an annuity
Premium Payments: This is the amount of money you, as the owner of the annuity, pay for the annuity to begin. It can either be an outright purchase (lump sum or single premium) or in the form of regular deposits over an agreed period time.

Contributions: When you own an annuity, you make contributions or payments into the annuity in order to build up the cash value within the annuity. Contributions can be made through payroll deductions, checks, or regular deposits.

Annuity Account: This is the type of annuity you decide to purchase such as a fixed, variable or index annuity with an immediate or deferred payout.

Annuity Maturity: When your annuity reaches maturity, you are given the option to either withdraw the entire amount including earnings (lump sum withdrawal) or to receive distribution over a set period of time. Or, you can start again with new contractual terms and conditions.

Annuity Penalties: As the owner of an annuity, should you wish to withdraw money from your annuity before age 59½, you will be assessed a 10% penalty (plus other income taxes) on the taxable dollars of your distribution. The insurance company also penalizes you for early withdrawal by deducting surrender charges or withholding interest credits if the annuity is not held to maturity.

Why should I consider an annuity?
Annuities have the advantage over traditional retirement plans of allowing you to contribute unlimited funds, tax-deferred.

Annuities provide you with an additional way to plan for retirement and allow you to choose the level of risk associated with your money. Fixed and fixed index annuities do not subject the principal and credited interest to risk. They also offer a minimum guaranteed rate of interest. Variable annuities are securities products that may provide (but are not guaranteed to provide) a higher rate of return. In contrast to a fixed or fixed index annuity, you can lose money in a variable annuity.

Another important feature of many annuities is that they contain the option for a death benefit. The insurance company guarantees, at a minimum, that upon your death your total contributions are paid to your beneficiaries.

Usually, with an annuity, you can withdraw a defined percentage of your money each year without surrender charges.

Finally, unlike life insurance, there is no medical prequalification required in order to be able to purchase an annuity. Should you so desire, you can purchase an annuity at any time.

The challenge with annuities
We've outlined the strengths of annuities but the major limitation with annuities occurs if you need to access your money before your annuity matures.

When you want to withdraw money from your annuity before its maturity date or before you turn 59½, you pay stiff penalties. First, the federal government assesses you a 10% tax penalty (plus other income taxes) on the taxable dollars of your distribution. Then, the insurance company penalizes you for early withdrawal by deducting surrender charges or withholding interest credits if the annuity is not held to maturity.

How FinancialBallGame.com can help you
You don't choose an annuity in a financial vacuum. You choose an annuity to fit into a lifelong financial strategy in which you understand the strengths that an annuity can bring to your strategy.

FinancialBallGame.com professionals do not use variable annuities due to the risk of loss of your contributions (i.e., your original principal). Instead, FBG focuses on the financial strengths of fixed and fixed index annuities.

These strengths include:

  • No loss of your contributions (protection of principal)
  • Guaranteed growth
  • Deferred tax benefits
  • Retirement income
  • Death benefit
  • No medical prequalification required to purchase

You also choose an annuity with the clear understanding of its limitations: lack of access to all of your money before the annuity maturity date along with tax penalties and high surrender charges if you want to access your money before the annuity matures.

Remember – very few financial products can be labeled as 'bad.' But if you do not understand the strengths and limitations of the financial product you are selecting, then you may run into trouble. This is true with annuities just as with any other financial product.

FBG professionals work with you to determine whether the purchase of an annuity fits within your lifelong financial strategy. If this financial tool works within your financial strategy, then FBG professionals ensure that you choose the appropriate annuity and issuing insurance company for your customized situation.

Choose to make smart, empowered choices with your money and for your future.

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