Funding your future with a fixed annuity

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By Doug Awad

A fixed annuity is a contract between you and an annuity issuer, usually an insurance company. In its simplest form, you pay money to an annuity issuer, the issuer invests the funds and pays you the principal and its earnings back to you or your named beneficiary. What’s fixed about a fixed annuity? The issuer guarantees (subject to its claim-paying ability) a minimum rate of interest on your investment and a fixed benefit amount if you elect to annuitize.

When is an annuity appropriate? Annuity contributions are made with after-tax dollars and are not tax deductible. That’s why it’s often advisable to fund other retirement plans first. However, if you’ve already contributed the maximum allowable amount to other plans and want to save more towards retirement, an annuity can be an excellent choice. There’s no limit to how much you can invest in an annuity, and the funds grow tax-deferred until you begin taking distributions. Once you begin withdrawing from your annuity, you’ll pay taxes (at your regular income tax rate) only on the earnings, since your contributions were made with after-tax dollars. Like a qualified retirement plan, a 10% tax penalty may be imposed if you withdraw from an annuity before age 59 ½, unless an exception applies. Annuities are designed to be long-term investment vehicles. In most cases, if you take a withdrawal, including a lump-sum distribution of your annuity funds within the first few years after purchase, you may be subject to surrender charges imposed by the issuer. However, many companies allow options for withdrawals or distributions without incurring a charge. As long as you’re sure you won’t need the money until at least 59 1/2 and you understand the costs (including fees), an annuity is worth considering.

Two distinct phases to an annuity There are two distinct phases to an annuity contract: the accumulation phase and the distribution phase. In the accumulation phase, you’re putting money into the annuity. You can choose to pay your premiums in one lump sum, or you can make a series of payments over time. These payments can be of equal amounts made at equal intervals, depending on the terms of the contract. Annuities may be either immediate or deferred; the terms simply refer to when the distribution phase begins. Immediate annuities are typically purchased with a single payment and the distribution phase usually begins within a year of the purchase. While deferred annuities may be purchased with a single lump sum premium payment, they can be purchased with a series of periodic payments. The distribution period is deferred until some time in the future. In the distribution phase you begin taking money out of the annuity. You may withdraw some or all the money in lump sums or you may annuitize. Subject to the claims paying ability of the insurer, annuitization provides a guaranteed income stream for either a specified period or for life.

Why buy an annuity? 1. It can provide income to supplement what you receive from Social Security, pension plans, and other employer sponsored retirement plans. 2. It can create a lifetime income stream. 3. It may enable you to maintain financial independence. For example, you can use annuity funds to pay for long-term care expenses and stay in your own home. 4. You can use it to invest for a specific purpose, such as providing a legacy for your heirs or making a charitable gift. 5. It will grow funds on a tax-deferred basis.

How a fixed annuity works 1. In the accumulation phase, you (the annuity owner) send your premium payments to the annuity issuer (through you financial advise). These payments are with after-tax funds and you may invest an unlimited amount. 2. The annuity issuer places your funds in a general account (these funds are invested as part of the general assets of the issuer and are subject to the claims of its creditors). Your annuity contract specifies how your principal will be returned as well as what rate of interest you’ll earn during the accumulation phase. 3. The compounding interest on your annuity accumulates tax deferred. You won’t be taxed on these earnings until they are withdrawn or distributed. 4. The issuer may

collect fees to manage your annuity account. You may also have to pay the issuer a surrender fee if you withdraw money the early years of your annuity. 5. Your annuity contract may contain a guaranteed death benefit or other provisions for a payout upon the death of the annuitant. 6. If you make a withdrawal from your deferred annuity before you reach the age of 59-1/2, you’ll not only have to pay tax (at your ordinary income tax rate) on the earnings portion of the withdrawal, but you may also have to pay a 10% premature distribution tax, unless an exception applied. 7. After age 59 ½, you may make withdrawals from your annuity without incurring any premature distribution tax. Since annuities have no minimum distribution requirements, you don’t have to make any withdrawals. However, your annuity contract may specify an age at which you must begin taking income payments. 8. To obtain a guaranteed fixed income stream for a certain number of years or life, you could annuitize which means exchanging the annuity’s cash value for a series of periodic payments. The amount of these payments will depend on a number of factors including the cash value of your account at the time of annuitization, the age(s) and gender(s) of the annuitant(s) and the payout option chosen. Usually, you can’t change the payments once you’ve begum receiving them. 9. You’ll have to pay taxes (at your ordinary income tax rate) on the earnings portion of any withdrawals or annuitization payments you receive.

Any annuity is a complex investment. If you have any questions, please call Doug at 352 854-6866 or by e-mail at Doug.Awad@raymondjames.com.

This information was developed by Forefield, Inc. an independent third party. It is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. Pat performance may not be indicative of future results. Raymond James 7 Associates, Inc. does not provide advice on tax, legal or mortgage issues. These matters should be discussed with an appropriate professional.

Doug Awad is a financial advisor for Raymond James & Associates. He will address any questions you have, but can’t guarantee the answers will appear in this column. E-mail your questions to Doug.Awad@ raymondjames.com, or call 854-6866.