The ABCs of Traditional, CD or Multi-Year Rate Guarantee Annuities	back to home

1. A traditional fixed annuity will customarily offer a one year rate guarantee. For example, let's say you transfer a CD to an annuity with a 7-year surrender schedule, and a first year interest rate of 6%. Most annuities contractually allow 10 % free withdrawals annually. Early withdrawal penalties would apply for withdrawals greater than 10% during the 7-year period. Your interest rate of 6% is literally guaranteed for one year, but the insurance company will declare an interest rate to be applied to your contract upon the 12 month anniversary, and every 12 month anniversary thereafter, until you receive a notice that your surrender schedule is over, at the end of year seven.
2. A “CD annuity” or multi-year rate guarantee annuity will be guaranteed for the length of time you agree to.   Let's assume you transfer a CD to an annuity with a 5-year surrender schedule, meaning early withdrawal penalties would apply for withdrawals greater than 10% during the five year period.  For example, a CD annuity or multi-year rate guarantee annuity may have a 5% interest rate guaranteed for the full 5-year term.
3. Finally a Partial Rate Guarantee annuity will have an interest rate guaranteed for only part of the surrender charge period. For example, let's say you transfer a CD to an annuity with a 7-year surrender schedule; meaning early withdrawal penalties would apply for withdrawals greater than 10% during the 7-year term. A partial guarantee may appear as "5% guaranteed for the first 4 years", but the final 3 years will have an interest rate declared annually by the insurance company thereafter.

What is a Tax-Deferred Annuity?

A tax-deferred annuity is a contract between you and an insurance company for a guaranteed interest-bearing policy with guaranteed income options. The insurance company credits interest, and you don't pay taxes on the earnings until you make a withdrawal or begin receiving an annuity income. Your annuity contract earns a competitive return that is very safe.

Tax-Deferred?

Tax-deferred annuity means postponing your taxes on interest earnings until withdrawal at a future point in time. In the meantime you are able to earn interest on your initial principal deposit, you earn interest on your interest, and you earn interest on the money you may otherwise have paid in taxes. You can accumulate more money over a shorter period of time, which potentially will provide you with more savings or a greater income.

Savings Advantages

Many people today are choosing tax-deferred annuities as the foundation of their overall financial plan. Why? The traditional savings dollar may be taxed every year in products such as CDs or mutual funds. By postponing that tax with a tax-deferred annuity, your money compounds faster because you can earn interest on dollars that likely would have otherwise been paid to the IRS. Later, if you decide to take a monthly income, your taxes may be less because they will be spread out over a period of years. Similar to CDs, annuities have a penalty for early surrender.

Safety

The safety tax-deferred annuities provide consumers, is traditionally cited as the #1 reason consumers place their savings in tax-deferred annuities. Your tax-deferred annuity is safe because qualified legal reserve life insurance companies are required to meet their contractual obligations to you. Tax-deferred annuities protect your principal, your interest, and your ability to make withdrawals, when you need income.

There are independent rating services that examine the financial health of insurance companies, such as A.M. Best, Standard and Poor’s, Moody’s, Weiss Research, and others.

Only insurance companies have the financial strength and the cash reserves to offer the guarantees found in an annuity. Mandated reserve requirements mean that when a tax-deferred annuity is purchased, the insurance company, by law, must set aside dollar-for dollar reserves to cover all anticipated payouts.

The investment risk is assumed by the insurance company rather than by the owner. Always remember that tax-deferred annuities guarantee your principal and interest. When you purchase stocks or mutual funds, you, not your stock broker or the firm for whom they work, assume the risk of the stock market.

By investing in a tax-deferred annuity, this risk is absorbed by the financial strength and the cash reserve of the insurance company. Plus, there is a state guaranty association to help pay claims, should an insurance company become impaired. The Guaranty Association is similar, in a sense, to the way banks are able to insure deposits up to $100,000 through FDIC insurance. Hence the "safety" of tax-deferred annuities.

Tax Advantages

You pay NO taxes on funds in your annuity while your money is compounding. You may also pay a lower tax on random withdrawals because you control the tax year in which the withdrawals are made, and only pay taxes on the interest withdrawn. Tax deferral gives you potential control over an important expense – your taxes.

The Tax-Deferred Advantage

It's not what you earn - but what you keep! Take a look at the effects of taxation on your investment earnings...

That's a difference of $119,609! The effect of triple compounding is mathematically superior to paying taxes annually. Eventually one will pay tax on their savings inside a tax-deferred annuity, but annuity holders control the distribution of their savings.

No More 1099s

There is no withholding tax on funds in your annuity while your account is compounding; it is completely tax-deferred. Only when your interest is distributed (because you request a withdrawal or annuity income), will Form 1099 be sent, reflecting the amount of interest actually received.

When Does My Money Mature?

Both your principal and interest will automatically continue to earn interest until withdrawn or until you reach age 100 (in most states). Annuity contracts, like certificates of deposit, last for a said period of time, three, five, ten, twelve, fourteen years etc. Just like a CD, you may choose a 3, 4, 5 year contract, or one that is longer, whichever suits your time horizon. You can let your money continue to grow, make free 10% withdrawals, or request annuity income distributed to you via US mail, or directly deposited into your checking or savings account.

What Is The Penalty Tax And When Does It Apply?

An IRS penalty tax, currently 10%, may be payable on any withdrawal of interest or qualified premium made prior to age 59 1/2. This 10% penalty can be avoided. If you decide to receive income payments prior to age 59 1/2, and you want to avoid this 10% penalty, you must take those payments in equal installments over your life expectancy, or for a minimum of 5 years, or to age 59 1/2, whichever comes first. This is called a 72T for IRA or other qualified funds like 401k money, or a 72Q calculation for non-qualified funds.

Avoid Probate

If a premature death should occur, the accumulating funds within your annuity may be transferred to your named beneficiaries, avoiding the probate process. Like most assets, however, the annuity is part of your taxable estate. Your heirs can choose to receive a lump sum payment, or a guaranteed monthly income.