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Annuity investments are a growing trend with financially savvy individuals who worry that Social Security and company pension plans won’t be enough to fully support their retirement fully. Fears that social security will one day run out coupled with the overall decrease in pension fund participation in America have compounded the interest in annuities (pun intended). At Lawhorn CPA Group, we work with business owners, as well as, employees, to maximize tax deferrals while promoting accumulation of wealth and retirement income. Annuities play a vital role in some individual portfolios, but for those of you considering investing in an annuity, we’ve compiled answers to some common critical questions. Whether you’re just beginning to plan for your retirement or are needing a supplement to your current retirement income, this article should help you answer the question, “Is an annuity investment right for me?” 

What is an Annuity?

Odds are you have heard of an annuity before, but very few Americans understand what they are and how they work. Annuities are kind of like a life insurance policy that pays you during your retirement (after age 59 ½). An annuity is a financial product offered primarily by insurance companies and represents a contract between you and the insurance company. In short, buying an annuity is a long-term investment to offer you income in regular payments to support your estate planning and retirement income goals. Annuities are purchased with after-tax dollars with no taxes due on earnings until you make a withdrawal, deeming them tax-deferred investments. It’s important to note here that if you do withdraw money from an annuity before you turn 59 ½, you may be subject to a 10% early withdrawal penalty. 

Benefits of an Annuity

Annuities are unique investments in that they offer benefits that aren’t found with other retirement savings plans. One of the primary benefits of an annuity is that they provide tax-deferred earnings without contribution limits or minimum distributions. Additionally, annuities offer individuals tax control, guaranteed death benefits, and lifetime income options. Because you choose when to withdrawal funds, annuities provide you with improved tax control.

The death benefits offered by this form of investment are unique to annuities. Death benefits offer your chosen beneficiary a guaranteed benefit if the contract owner dies unexpectedly. This guaranteed benefit includes the amount of principal minus any withdrawals or the current account value. So, if a client invests $75,000 and passes away four years later when the account value is $145,000, the beneficiary will receive the full $145,000. Another advantage of an annuity where death benefits are concerned is that even if the account value has decreased, the beneficiary is entitled to the original cost of the account. Let’s say our previous example client investment of $75,000 drops to $50,000; the beneficiary will still receive $75,000. 

Finally, another benefit of annuities is their lifetime income options, which are also unique to this form of investment. Annuity lifetime income options offer a pension-like payout that prevents retirees from outliving their assets. Payout plans for annuities vary, but some of the more common include, a single life payout, a joint and survivor payout, a period-certain payout, and the life with an installment payout. 

Types of Annuities

Annuities come in several different types based on your investment goals. A financial advisory firm can help you decide which plan best fits your desired income options. Generally, you have four primary types of annuities to choose from, including a variable annuity, a fixed annuity, an immediate annuity, and a fixed indexed annuity. 

Variable Annuity: A variable annuity holds the possibility of both more risk and more earnings. Operating like an Exchange Traded Fund (ETF) or mutual fund, variable annuities allow you to select a portfolio of accounts (sometimes called subaccounts) that you want to fund your account. Payouts for a variable annuity are based on how well those funds perform in the marketplace. The investment and principle value in a variable annuity fluctuate. Assuming no withdrawals are made, the total account value of your annuity could swing widely. The guaranteed death benefit will pay out either the original principal or the highest anniversary value, whichever is greater. 

Fixed Annuity: Fixed annuities are very similar to a savings account. A fixed annuity grows your investment based on a guaranteed rate of return. With a fixed annuity, you pay a lump sum and in return the insurance company promises to credit you a stated rate of interest for a specified period. 

Fixed annuities are fitting investment vehicles for more risk-averse individuals, as they offer a principal and interest payment regardless of the current market, as long as the annuity is held during the guarantee period (sometimes referred to as a surrender-charge period). Guarantee periods can last from one to ten years with a higher rate of interest being paid for longer guarantee periods. It’s important to note that while fixed annuities are comparable to a savings account, they are not insured by the FDIC or backed by the US Government. 

Immediate Annuity: An immediate annuity, as the name suggests, converts a lump sum of money into an immediate stream of income. Each payment that the insurance company makes to you is a partial return of principal and part earnings, which means the principal portion of the insurance payout is excluded from income tax. Most immediate annuities are structured as fixed payments; however, some insurance companies also offer immediate variable annuities as well. 

Fixed Indexed Annuity: A fixed indexed annuity offers the potential for increased earnings based on an index’s growth (think S&P 500), but also includes downside protection. This means that your fixed indexed annuity’s principal investment will not decline if the index performs poorly, protecting your principal no matter what the index does. There is also more opportunity for growth versus a fixed annuity and less risk, although your potential return value is even lower than with a regular fixed annuity. It’s important to understand that your fixed indexed annuity’s performance isn’t based on the index itself but rather on the underlying index performance. 

Why Buy an Annuity?

Retirement planners and financial advisory firms generally recommend annuities to members of the baby boomer generation and younger boomers who are helping their older parents with investment choices. Usually, younger people are less risk-averse, as they have more time to make up any loses and don’t find annuities as attractive compared to other investment vehicles. Alternatively, individuals who are closer to retirement are more willing to sacrifice some gains in exchange for the security of guaranteed payments. Because annuities provide gains typically higher than your normal certificate of deposit but with less risk than an EFT, they are more popular with adults in the later seasons of their “earning years.” 

Therefore, the question, “should you buy an annuity,” can only be answered after you’ve created a financial plan. Once you have your financial goals in place and begin obtaining quotes on annuities from insurance companies, some essential factors that you should be aware of are the surrender fees (when you withdraw money early or cancel the annuity), churning, and buybacks. An advisable strategy to purchasing an annuity is to collect your quotes and bring this paperwork to a Financial Advisory Specialist or Certified Public Accountant to help explain the term of the agreement in full.

Financial Advisory Help with Annuities

When planning for your financial future, it’s more important than ever to find an investment vehicle that helps you avoid loses and provide reliable income in times of market volatility. Depending on your investment goals, this may make annuities right for you. Lawhorn CPA Group’s client chooses us to help them navigate the complex and often confusing path to tax-deferred retirement savings during shifting market conditions. Contact us online or at (865) 212-4867 to gain access to a value-priced financial consultant, that will navigate you to a robust financial finish and comfortable retirement.

If you have access to the outside world at all, you are probably fully aware of the coronavirus that has been sweeping the world. In an effort to  keep you informed, we’ve gathered some information on what this could mean for this tax filing season and what we’re doing to prepare.