Annuities help ensure that you do not outlive your income. When you invest in an annuity, you must decide when to begin receiving your benefits. You can choose to begin receiving your benefits immediately or to defer them to a later date, such as retirement. If you choose to defer your benefits, you contributions and interest will grow tax deferred until you begin withdrawing them.
Functions
Deferred annuities have two phases, the investment phase and the income phase. Deferred annuities allow you to make a lump sum payment or periodical payments into an investment account and withdraw that money, plus interest, at a later date. The money withdrawn from a deferred annuity is usually used as retirement income.
Advantages
Contributions and interest grow tax deferred, in an annuity, until withdrawals or scheduled payments begin. Many payout options are available with a deferred annuity, including straight life, refund life, installment certain, joint life and temporary annuity certain. Payout options, such as refund life, installment certain and temporary annuity certain, offer death benefits to your beneficiaries.
Disadvantages
Deferred annuities are meant to provide income at a later date. If you decide to withdraw money early from a deferred annuity, it is subject to a 10 percent tax on early withdrawals, as per the Internal Revenue Service, IRS, guidelines. Also over the years, inflation eats away at the value of your annuity.
Types of Deferred Annuities
The three basic types of deferred annuities are fixed annuities, variable annuities and index annuities. Fixed annuities, where the insurance company assumes the investment risk, have a guaranteed interest rate that does not change over a specified time period. These are often considered conservative or low- risk investments. With a variable annuity, you assume the investment risk and there is no guarantee on the interest or even the principal. The value of your investment will fluctuate with the values of the market where the money has been invested. Index annuities are a mixture of the fixed and variable annuity. Although the principal is guaranteed, the interest rate is tied to increases in the market index.
Regulations
Fixed annuities are regulated by each state's department of insurance. They can only be purchased by someone possessing a valid life insurance license. Variable annuities are regulated by each state's department of insurance and the Securities and Exchange Commission. They can only be purchased from someone who has a valid life insurance license and is registered with the Financial Regulatory Authority, meaning they have a series 6 or 7 license. Because index annuities closely resemble fixed annuities, they are only regulated by each state's department of insurance and can be purchase from a licensed life insurance agent. According to Securities and Exchange Commission though, in January 2011, index annuities will be subject to federal securities regulations.
References
- AnnuityTruth: Annuity Basics
- IRS: General/Taxability Issues including Distributions and Early Withdrawals
- FinanciaWeb: 3 Things to Know About Deferred Annuity Rates
- Investopedia: Watch Your Back in the Annuity Game
- Securities and Exchange Commission: SEC Final Rule: Indexed Annuities and Certain Other Insurance Contracts
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