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By Paul A. Pouliot
Life insurance companies first developed annuities to provide income to individuals during their retirement years.
This function is in contrast to the benefits that a life insurance policy provides to your beneficiaries after your death. Although annuities were first developed to fund an annuitant’s retirement years, there is no requirement that an annuity be used only for retirement purposes. In fact, annuities may be and are used to fund other financial goals, such as paying for a child’s education or starting a business.
Example(s): Liz is a highly successful entrepreneur. Her business has grown far beyond what she has ever imagined, but her long hours have taken a toll on both her and her family. Liz plans to sell the company in the near future and pursue her lifelong interest in landscape painting full-time. Even though she expects a modest income from the sale of her paintings, Liz will use the sale proceeds from her company to purchase an annuity that will provide her with regular, guaranteed income for the rest of her lifetime. Sam’s company does not offer a retirement plan, and he has already contributed the maximum amount to his individual retirement account (IRA). Knowing that he can and needs to save more aggressively for retirement, Sam purchases an annuity to which he will contribute regularly until he retires. He will then receive a guaranteed income stream from the annuity in addition to receiving Social Security and income from his IRA.
Caution: Guarantees are subject to the claims-paying ability of the annuity issuer.
How do annuities differ from other retirement plans?
Annuities differ from other types of retirement plans in several important ways. Contributions are not tax deductible. Unlike contributions to a qualified retirement plan, money you invest in an annuity is not tax deductible. Any money that you use to purchase an annuity will be after-tax income. (However, like a qualified retirement plan, interest and capital gains earned by an annuity will accrue tax deferred until you begin withdrawing the money from the annuity.)
Contributions are unlimited
All qualified retirement plans have limitations on how much you can contribute each year. With many plans, the amount that can be contributed is quite low. However, there is no limitation on how much you can invest in an annuity. If you win a lump sum of $1 million in the lottery, you can invest the full amount (after paying the applicable income taxes, of course) in an annuity.
May receive income for life from annuity
One of the unique features to an annuity is that you cannot outlive the income payments (assuming you elect to receive the payments over your entire lifetime). With some types of qualified retirement plans, you will receive payments from the plan only until all the money in the retirement account is depleted. There is the real possibility that you will outlive the money available in the account. Some qualified retirement plans do offer their beneficiaries the option to convert monies in the account into an annuity upon retirement.
The money that you use to purchase an annuity may be placed in the annuity issuer’s general funds pool. The money is then invested and managed by the issuer’s own money managers. Some types of annuities (called variable annuities) allow you to place your annuity funds in specific investment pools, typically called subaccounts. The funds are managed by an investment advisor. You may then be able to move your annuity investments between stocks, bonds, money markets, or other types of investments. Caution: Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk including the possibility of loss of principal.
Variable annuities contain fees and charges including, but not limited to mortality and expense risk charges, sales and surrender (early withdrawal) charges, administrative fees and charges for optional benefits and riders. Variable annuities are sold by prospectus. You should consider the investment objectives, risk, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity, can be obtained from the insurance company issuing the variable annuity or from your financial professional. You should read the prospectus carefully before you invest.
What are the advantages to annuities? Earnings accrue tax deferred
As noted, one of the main advantages to an annuity is that the interest generated by an annuity accrue tax deferred. Over a long period of time, this deferral of taxes on earnings is an advantage for an annuity over a comparable taxable investment.
Guaranteed payments for life
Another advantage to an annuity is that you can receive payments from the annuity for your entire lifetime. As long as you elect to receive payments over your entire lifetime when the payout period begins, you will receive the payments for as long as you are alive. Even if you live to the age of 100, the annuity issuer must make the payments to you.
No contribution limits
Unlike qualified retirement plans, there is no limit on how much you can invest in an annuity. Many different types of annuities available In recent years, there has been a huge increase in the number and variety of annuities available in the marketplace. There are numerous fixed annuities, variable annuities, and equity-indexed annuities that an individual can choose.
Can delay payout until later age
With most qualified retirement plans, you must begin taking money out of the plan by a certain age (usually 70½). With an annuity, there is no age limit at which you must begin receiving payments from the annuity. If you do not need the money from the annuity, you can continue to have the earnings accrue tax deferred.
Proceeds avoid probate
If you die before the distribution period begins, then the money you have invested in the annuity (plus any accrued interest or earnings) does not have to be included in your probate estate if you have named a beneficiary on the annuity. The money in your annuity will pass directly to that named beneficiary. Because of the potential delays and costs in having your assets pass through probate, most estate planners recommend that you try to avoid having assets pass through probate.
For more information: Contact: Paul A. Pouliot & Associates; Paul A. Pouliot, Senior Financial Advisor, 116 South River Rd, Coldstream Park, Bldg E, Bedford NH 03110. PH: (603) 296-0030 or Toll Free: (888) 810-8590. Email: email@example.com / www.ameripriseadvisors.com/ paul.a.pouliot
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