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Making Sense Out of Dollars

“A” is for Annuities

Joel Lerner
Posted 2/11/22

Part 5 of 17

What are the Different Characteristics of Annuities?There are several different types of annuities. They can be categorized according to three main characteristics: 1) Premiums, 2) …

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Making Sense Out of Dollars

“A” is for Annuities

Posted

Part 5 of 17

What are the Different Characteristics of Annuities?
There are several different types of annuities. They can be categorized according to three main characteristics: 1) Premiums, 2) Payment Return and 3) Return on Investment. Last week we discussed 1) Premiums. Today, (2) Payment Return.
2) Payment Return
A. Immediate Annuity – An annuity may provide for either immediate return to the investor or deferred return. An immediate annuity is purchased at the time you want to start receiving income and requires a single lump-sum payment. The insurance company begins sending you monthly checks right away. One of the most important advantages of a fixed-rate immediate annuity is that it allows you to lock in an interest rate for the rest of your life when rates are high. You always know how much you will receive. However, bear in mind that once the rate is set, it can never change. If current rates drop, you know you did the right thing; but if they should rise, there isn’t anything you can do about it but feel bad. Also, that fixed amount today may seem high but diminishes as time goes by because of inflation as we are experiencing today.
The overarching characteristic of the immediate annuity is that it is a vehicle for distributing savings with a tax-deferred growth factor. A common use for an immediate annuity might be to provide a pension income. In the U.S., the tax treatment of a non-qualified immediate annuity is that every payment is a combination of return of principal (which part is not taxed) and income (which is taxed at ordinary income rates not capital gains rates).
The Deferred Annuity – The second usage for the term annuity came into being during the 1970’s. Such a contract is more properly referred to as a deferred annuity and is chiefly a vehicle for accumulating savings with a view to eventually distributing them either in the manner of an immediate annuity or as a lump-sum payment.
Deferred annuities in the United States have the advantage that taxation of all capital gains and ordinary income is deferred until withdrawn. In theory, such tax-deferred compounding allows more money to be put to work while the savings are accumulating, leading to higher returns. A disadvantage, however, is that when amounts held under a deferred annuity are withdrawn or inherited, the interest/gains are immediately taxed as ordinary income.

Thought for the Week

The leaders of the French Revolution excited the poor against the rich. This made the rich poor, but it never made the poor rich.

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