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Annuities are long-term investment
tools for supplementing retirement income. There are
no IRS-imposed annual contribution limits, and annuity
earnings grow tax-deferred until the funds are
withdrawn or paid out as income.
Though popular among today’s aging Baby Boomers and
members of the Mature or “Senior” markets,
annuities can be traced back to ancient Greece. The
term “annuity” comes from the Greek word
“annus”—or “year”—and refers to annual
income payments. Similarly, in ancient Rome citizens
would make one-time payments to a contract called
“annua” in exchange for lifetime payments made
once a year.
In 17th century Europe, annuities were used as
fundraising devices by governments to finance their
ongoing wars with neighboring nations. These
governments would offer “tontines,” which promised
payments into the future to those who bought shares.
In the 18th century annuities were introduced to North
America, with private insurance companies selling
insurance and annuity contracts to individuals wanting
to avoid outliving their resources, In 1759 in
Pennsylvania a company was formed to benefit
Presbyterian ministers and their families. The
ministers would contribute to a fund, in exchange for
lifetime payments. In 1912, the Pennsylvania Company
for Insurance on Lives and Granting Annuities became
the first American company to offer annuities to the
public.
However, annuities experienced a huge growth in
popularity during the late 1930s when the collapsing
financial markets turned many people away from
equities in favor of products from more secure
institutions—insurance companies that could and did
make annuity payments, as promised.
Early annuities were simple contracts guaranteeing a
return of principal and fixed rates of return from the
insurance company during the accumulation phase. At
withdrawal, the annuitant chose either a fixed income
for life or payments over a specific number of years.
Buyers have always been drawn to annuities by their
tax-deferred status. As a consequence of being issued
by insurance companies, annuities have always been
able to accumulate without taxes being taken out at
year-end, which has added the time value of money to
their list of advantages.
The most recent major development has been the
inception in 1952 of variable annuities, which offer
the investment features of separate mutual fund
accounts inside the annuity with the tax-deferral
available from life insurance products. Variable
Annuity owners choose the type of accounts to use,
often receiving modest guarantees from the issuer in
exchange for the greater risks assumed.
“The shift to investment-linked annuities has been
so marked that 25,000 investment-linked annuities were
sold [in 2001] - 9.5% of all annuity business,”
reports Peter Quinton is managing director of The
Annuity Bureau, adding that “it's likely that the
popularity of these annuity will continue to increase
as they are the only at-retirement products that offer
retirees a half-way house between the two extremes of
purchasing a safe conventional annuity and opting for
a investment-linked income drawdown plan, where the
cross-subsidy system does not apply.” Source:
Pensions Management; 12/1/2002
Wider Choices
Although long part of well-diversified financial
portfolios, annuities have continued to evolve. Recent
developments have included features such as adding
checkbook access to Variable Annuity funds, more
attractive "bonus" rates, shorter maturity
periods, and guaranteed death benefits.
But consumers now have wider choices of annuity types,
plus more investment options and guarantees to fit
their investment and income goals. For example, some
annuities offer guaranteed bonus interest rates for
the first few years or guaranteed returns for the life
of the contract. Other annuities guarantee
beneficiaries the return of principal if the annuitant
dies and the annuity stock market investments have
lost value.
Although annuities have evolved, their primary
objective remains the same. That is, being able to
lock in a guaranteed payout that cannot be outlived.
As people live longer, healthier lives--and the
equities markets remain subject to unsettling
fluctuations--financial products offering safety,
flexibility and guaranteed returns are increasingly
appealing to older consumers. However, investors of
all ages are drawn to variable annuities whose return
is tied to the stock market, but which also offer
guaranteed minimum returns not tied to market
performance.
Annuities are accessible. Because there are no
contribution limits, people can invest as much or as
little as they chose in annuities no matter what their
income levels. And this money grows on a tax-deferred
basis until the accumulated earnings are distributed,
usually at retirement.
Moreover, unlike other tax-deferred investments during
the distribution phase, annuities’ tax-deferred
earnings are not counted in determining a person’s
income taxes on Social Security benefits. At the same
time, while annuitants cannot outlive their guaranteed
benefits, properly structured annuity contracts and
beneficiary designations can:
1) avoid probate,
2) protect assets held in trust from mismanagement by
a parent of guardians, and
3) continue benefits to the annuitant’s heirs, thus
making annuities effective multigenerational planning
vehicles.
Market Overview
With their unique advantages, a growing market for
annuities has grown among individuals with longer-term
wealth accumulation and retirement planning needs, as
well as individuals with immediate income needs. Let's
consider how two types of annuities can be used to
address the wealth accumulation and retirement
planning problems we all face. These are:
• Non-qualified Annuities
• Qualified Annuities
Non-Qualified Annuities -- Non-qualified annuities are
purchased with after-tax dollars to meet longer-term
wealth accumulation or retirement planning needs--with
emphasis on longer-term.
As noted, deferred annuities may not be appropriate
for shorter-term wealth accumulation purposes —
generally those that will materialize before age 59½;
while immediate annuities are designed to provide
long-term income — that is, income guaranteed for
life.
Non-qualified annuities are used to fund cash
accumulation programs that do not qualify for a
front-end tax deduction; but whether an annuity is
qualified or non-qualified, premiums always accumulate
interest that is free of current income tax until
withdrawn. But non-qualified annuities also allow
owners to continue tax deferral beyond the age 70, the
mandatory withdrawal age for traditional IRA's and
qualified retirement plans.
Qualified Annuities-- Annuities can also accommodate
tax-qualified money. A qualified annuity is used to
fund a tax-qualified retirement plan such as a
traditional IRA or an HR-10. Thus in most cases,
premiums paid to qualified annuities are
tax-deductible. For instance, when people change jobs
and have 401(k) funds to move or already have IRAs and
are seeking a more diversified portfolio. They can
reduce their portfolio exposure by rolling the money
over into an annuity without losing tax advantages.
Or suppose Alice inherits $20,000. If she doesn’t
need the money right away and wants to build a
long-term nest egg, she might consider putting the
inheritance into an annuity. By doing so, she’ll
gain the advantage of tax-deferral, and when it’s
time to withdraw funds from her non-qualified annuity,
Alice will only be taxed on the accumulated interest,
not the principal.
Generally, annuities are not suitable estate planning
vehicles, but are useful in meeting immediate and
retirement income needs. Thus, iif you’re a
candidate for wealth accumulation and retirement
planning, remember: "The only person who can take
care of the older person we will someday be is the
younger person we are now."
By w.willard3@knology.net
Bill Willard: Bill Willard has been writing
high-impact marketing and sales training for the
financial services industry for over 30 years. Through
interactive, Web-based "Do-While-Learning™"
programs, e-Newsletters and straight-talking articles,
Bill helps agents and advisors get the job done:
profitably improving performance, skipping expensive
mistakes, and making the journey to success faster,
smoother, easier. And fun!
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