The Ins and Outs of Annuities

Annuities can be powerful investment vehicles, providing a tax-efficient means to accumulate assets, secure a source of guaranteed income for life, or the means to realize other financial goals. ¹ Unfortunately, some who would benefit most from owning an annuity shy away from them simply for lack of understanding. The truth is, when you look at the basic design of an annuity, it’s pretty simple. And, it may be just the thing to help make your retirement years more financially secure.

In a nutshell, an annuity is a contract you purchase from an insurance company. You put money in (either a lump sum or periodic payments) and your dollars accumulate on a tax-deferred basis. This means you don’t pay taxes on your accumulated earnings until you start receiving payments, usually in retirement. In addition, the insurance company agrees to pay you (and/or your beneficiary) guaranteed payments either for a specific period of time or for your lifetime. Annuities are said to be “self liquidating” because in the payout phase they pay a steady stream of income every month, a portion of which is an earnings and a portion of which is a “tax-free” return of the money you put in.

While annuities come in a wide variety of choices, there are basically two types, immediate annuities, which start making payments as soon as you purchase the contract, and deferred annuities, which grow your assets over time, then start making payments sometime in the future.

With both immediate and deferred annuities, you decide how you want the money to be invested by selecting either a variable or fixed variety. With a variable annuity (available from registered representatives only), you control where the money is invested, typically in stock, bond or real estate funds, and you bear the investment risk. With a fixed annuity, the insurance company makes the investment choices and pays you a specified rate of return with a minimum guaranteed interest rate.

No matter what kind of annuity you choose, when the time comes for payments to begin, there are several basic options from which you can choose: ¹

• A specified period annuity provides payments for a specified number of years. If you die before the end of the period, payments continue to your beneficiary for the remainder of the period.
• A straight life annuity provides payments for your entire lifetime. The downside is that payments stop when you die; regardless of how many (or few) payments you received.
• The payments from a life and certain period annuity also last your entire lifetime. In addition, if you die before a “certain” number of years (usually 10 or 20), payments are guaranteed to continue to your beneficiary for the remainder of that period. For this assurance, you receive a slightly lower payment than offered by a straight life annuity.
• An installment refund annuity also provides somewhat lower payments than those offered by a straight life annuity, but will total at least the amount of money you paid into the contract, regardless of when you die. Any “refund” is paid to your beneficiary.
• A joint and survivor annuity provides an income for as long as either you or your designated survivor lives. You can also add a “certain period” to this payment option.

Before you buy an annuity, make sure you consider a number of factors that can vary from one annuity to the next. For example, are there contractual or income tax penalties for early withdrawals? How long do the surrender charges last? How much can you withdraw at any time without a surrender charge? You should also ask:

• What is the current interest rate and how often does it change?
• What is the guaranteed minimum interest rate?
• Are there “bail-out options” that permit you to cash in the annuity without withdrawal penalties (there may be tax penalties) for nursing home care or terminal illness?
• What are the sales loads or administrative fees and how will they affect your return?
• What additional charges are deducted from your investment?

Annuities are a popular investment choice, providing an important source of retirement income for many Americans. Carefully consider your options when purchasing an annuity.

For more information, visit the Northwestern Mutual Financial Network website at www.nmfn.com or by visiting the Insurance Information Institute’s website at www.iii.org.