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What is a fixed annuity, a variable annuity?
Simply put, both the fixed annuity and the variable annuity are amounts to be paid annually. More specifically, these are contracts offered by insurance companies that allow you to save money for retirement on a tax-advantaged basis and then, if you choose, receive a guaranteed income that is payable for life or over a period of time, such as five, ten or twenty years. years. Payments are usually monthly, but many companies offer to pay quarterly, semi-annually or annually. Much of the discussion will focus on the fixed annuity.
How do they work?
Both the fixed annuity and the variable annuity are means of accumulating savings for retirement. You pay a premium to an insurer and they promise to pay you interest. Unlike other retirement savings vehicles, as long as you keep your money with the insurer, you don’t have to pay income tax on your gains.
This is called “tax deferral”. Only if you decide to withdraw your money will the profit be subject to income tax. A fixed annuity differs from other retirement savings plans in another important way. When you decide to withdraw your funds, the insurance company gives you the opportunity to receive a guaranteed income for as long as you live.
What are the benefits?
All fixed annuity options have three main benefits: tax deferral, estate avoidance and guaranteed income for life.
Who offers fixed annuity products?
Fixed annuities are only offered by insurance companies licensed to provide life and annuity insurance by your state. Most insurance companies have financial requirements that dictate how much reserves the company must maintain on its policies.
Who sells them?
Only agents licensed by the government to sell life insurance can sell you a fixed annuity. This includes all licensed life insurance agents in the state, as well as most financial planners and stock brokers.
Why is guaranteed income for life an advantage?
An annuity is the only savings vehicle that offers guaranteed income for life. With any other type of accumulation plan, you can never be sure that your income will last as long as you live. The insurance company calculates the payment of the guaranteed income based on your age, life expectancy and the interest rates it credits. This payment is guaranteed for as long as you live.
Most insurance companies also offer fixed income guaranteed for a specific period of time, such as five to twenty years. The guaranteed lifetime income can be based only on your life, or on the life of you and the joint annuitant, typically your spouse. In the case of a joint annuity, the monthly income from the fixed annuity continues until the death of the last survivor.
What does tax deferral mean?
The tax-deferred fixed annuity receives special tax benefits. Under current tax laws, interest or profit is not taxable until you actually earn the income, meaning tax on the profit is deferred. Therefore, because you pay no taxes while your money earns interest, you earn interest in three ways: interest on principal, interest on interest, and interest on taxes you would have paid if you were not tax-deferred. This deferred annuity results in increased earning power over and above the bank CD or other fully taxable earnings.
Why is inheritance avoidance beneficial?
The other primary advantage over most other all-annuity investment vehicles is that you can pass the income directly to the beneficiary upon death. Probate is a court procedure to determine the validity of a will. Assets in the estate generally cannot be passed on to the heirs until the probate court has determined the validity of the will and authorized the probate to distribute. Because probate is a court process, it can take anywhere from six to twelve months to complete, and legal costs can be significant.
In contrast, income from annuities and life insurance policies are not subject to probate and can be passed directly to the named beneficiary without probate.
What does the insurer need to fulfill its obligations?
The insurance company must meet strict financial requirements to protect the funds of policy holders or policy holders. Most importantly, these requirements include the creation of a reserve that must at all times equal the surrender or surrender value of the entire block of variable and fixed annuity policies or contracts.
In other words, the insurance company must set aside an amount equal to the surrender value (principal plus interest less early withdrawal or surrender costs) of each existing annuity contract. In addition to these reserve requirements, state laws also require certain levels of capital and surplus to further protect contractholders or policyholders.
The immediate annuity allows the payment of the fixed annuity to begin immediately after the date of purchase. Payment can be scheduled monthly, quarterly, semi-annually or annually by prior agreement.
Often, proceeds from life insurance or the sale of a home are used to fund an immediate annuity. Such annuity payments provide immediate, regular income for a certain period of time (5, 10, 15, 20 years), or even for a lifetime, depending on the decision of the direct annuity owner.
A deferred annuity requires payments to begin at a future date known as the maturity date. A deferred annuity has an accumulation period and a payment or distribution period.
For example, a middle-aged wage earner can provide an income supplement in his retirement years by purchasing a deferred fixed annuity. Lump sum or regularly scheduled payments would be made into the annuity account as it accumulates, and then at age 65 when the annuity expires, additional income would be available through scheduled annuity payments.
One-time premium annuity
A fixed annuity can be purchased for a one-time fee, in which a cash payment is the basis of the contract.
The most common sources of such lump sums are life insurance death benefits, a home sale, or lottery winnings.
Flexible premium annuity
A fixed annuity can be financed over time with an initial fee and additional flexible fees.
Both the amount and frequency of the premium can be flexible, allowing for convenient financing plans, such as salary deductions after several years of employment, as well as changes in the owner’s financial situation.
What is a fixed indexed annuity?
A fixed indexed annuity (also known as an indexed annuity, indexed annuity, or equity-indexed annuity) is a fixed annuity that has upside earning potential and guarantees downside loss of principal. Your income is tied to a stock or stock market index, such as the Standard & Poor’s 500 Composite Stock Price Index or simply the S&P 500. Fixed indexed annuities (FIAs) have four guarantees:
1. The initial fee is guaranteed
2. Minimum rate of return
3. Accept market increases (rises), not corrections (decreases)
4. Profits are locked in every year
How are they different from other fixed annuities?
The primary difference between a fixed indexed annuity and other fixed annuities is how the annuity rate or income is credited to your account. A traditional fixed annuity credits interest with the annuity calculator fixed in the contract and may be subject to market adjustments. A fixed indexed annuity results in an interest credit formula based on changes in the stock market to which it is linked. This formula determines how interest is calculated, credited, how much additional interest you get, and when you get it.
The insurance company issuing the fixed indexed annuity also promises to pay a guaranteed minimum interest. Even if the indexed income is lower, the minimum guarantee will apply and the account value will not fall below the guaranteed minimum. Both flexible fee and lump sum deferred annuity contracts guarantee a minimum interest rate, often between 1.5% and 3%, based on a ratio of 90% to 100% of the premium paid. The insurance company’s annuity calculator changes the invoice values at the end of each term.
What are the contract features or “moving parts”?
The amount of additional interest that can be credited to the fixed indexed annuity is mostly influenced by the indexation method and the participation rate, as well as the form and function together.
INDEXING METHOD is the design by which the rate of change of the index is measured. For example, a method that measures the difference between the starting index level and the one-year anniversary level on a yearly point-by-point basis. If this scheme “keys” the account value (new capital) with each annual gain, the indexing method includes an annual reset feature. Currently, the industry’s best-selling equity-indexed annuity is Allianz’s MasterDex Annuity series, which includes a “monthly” point-by-point progressive system and annual reset. The functional differences between the indexing methods are described in more detail below.
Similar to the faucet, the PARTICIPATION RATE determines how much of the increase in the index will flow into the value of the annuity account. Let’s say the fixed annuity calculator shows a 12% increase in the index, but the participation rate limits it to 70% of the gain. The annuity growth rate is 70% of 12% or 8.4%. Participation rates are variable and may only be guaranteed for a specified period or guaranteed not to adjust below a specified minimum or above a specified maximum. One of the most popular fixed indexed annuities is the Sun Life Financial Keyport Index Multipoint, which guarantees a 100% participation rate for the entire term of the contract.
Some fixed indexed annuities place a CAP or cap on the annuity rate, setting the upper limit the annuitant can earn. An annuity with an index-linked, say 9% interest rate can only have an upper limit of 7%, which would be the amount of credited growth.
Some annuities use Averaging to smooth out the highs and lows of a linked stock market index. For example, monthly averaging would use an annuity calculator that combines the index closing values between each month divided by 12.
Some annuities reduce the index-linked interest rate by deducting the SPREAD, MARGIN or FEE and crediting the balance. For example, an 11% positive change in the index would result in a net increase of 8.5% with an administration fee of 2.5%. For carriers that sell annuity products with premiums, margins or fees, such amounts are deducted only if the remaining index change is a positive revenue rate.
Annual Reset: The return is determined each year by comparing the index value at the end of the contract year with the index value at the beginning of the contract year. The positive difference, if any, is the return that the fixed indexed annuity earns over the year. Any new positive (not negative) account value will reset and become the new starting point for the next year. Compare this formula to owning a variable annuity or a direct stock investment in a bear market. With variables and stocks, the owner has to climb out of a deep valley before settling back to zero.
High-Water Mark: The return is determined by the increase in the value of the index at the annual anniversary points of the contract during the term. The positive difference, if any, is determined by comparing the highest index value with the index value at the beginning of the term.
Point-to-point: The return, if any, is determined by comparing the difference between the index value at the end of the term and the index value at the beginning of the term. The positive difference is added to the value of the annuity account at the end of the term.
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