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What is an Annuity?
An annuity is a contract in which an insurance company makes
a series of income payments at regular intervals in return for a premium
or premiums you have paid. Annuities are often bought for future retirement
income. Only an annuity can pay an income that can be guaranteed to
last as long as you live. Your money grows tax-deferred as long as
you leave it in the annuity.
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Examine Different Kinds of Annuities
The most common types of annuities are: single or multiple
premiums, immediate or deferred and fixed or variable.
For a single premium contract, you pay the insurance company only one
payment, whereas you make a series of payments for a multiple premium.
With an immediate annuity, income payments start no later than one
year after you pay the premium. The income payments from a deferred
annuity often start many years later. Deferred annuities have an accumulation
period, which is the time between when you start paying premiums and
when income payments start. During the accumulation period of a fixed
deferred annuity, your money, less any applicable charges, earns interest
at rates set by the insurance company or in a way spelled out in the
annuity contract. During the payout period, the amount of each income
payment to you is generally set when the payments start and will not
change. During the accumulation period of a variable annuity, the insurance
company puts your premiums, less any applicable charges, into a separate
account. You decide how the company will invest those premiums, depending
on how much risk you want to take. During the payout period of a variable
annuity, the amount of each income payment to you may be fixed (set
at the beginning) or variable (changing with the value of the investments
in the separate account.
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Know How Interest Rates are Set
During the accumulation period, your money, less any applicable
charges, earns interest at rates that change from time to time. Usually,
what these rates will be is entirely up to the insurance company. The
current rate is the rate the company decides to credit to your contract
at a particular time. The company will guarantee it will not change
rates for a certain time period. The minimum guaranteed interest rate
is the lowest rate your annuity will earn. This rate is stated in the
contract. Some annuity contracts apply different interest rates to
each premium you pay or to premiums you pay during different time periods.
Other annuity contracts may have two or more accumulated values that
fund different benefit options. These accumulated values may use different
interest rates. You get only one of the accumulated values depending
on which benefit you choose.
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Know What Charges May be Subtracted from Your Fixed Deferred
Annuity
Most annuities have charges related to the cost of selling
or servicing it. These charges may be subtracted directly from the
contract value. Ask your agent or company to describe the charges that
apply to your annuity. Some examples of charges, fees and taxes are
surrender or withdrawal charges, free withdrawal, contract fee, transaction
fee, percentage of premium charge and premium tax.
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Contract Benefits of Fixed Deferred Annuities
Companies may offer various income payment options. You or
another person that you name may choose the option. If you choose Life
Only, the company pays income for your lifetime. Life Annuity with
Period Certain pays income for as long as you live and guarantees to
make payments for a set number of years even if you die. If you choose
Joint and Survivor, the company pays income as long as either you or
your beneficiary lives. In some annuity contracts, the company may
pay a death benefit to your beneficiary if you die before the income
payments start.
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Tax Treatment of Annuities
Under current federal law, annuities receive special tax treatment.
Income tax on annuities is deferred, which means you are not taxed
on the interest your money earns while it stays in the annuity. Tax-deferred
accumulation is not the same as tax-free accumulation. An advantage
of tax deferral is that the tax bracket you are in when you receive
annuity income payments may be lower than the one you are in during
the accumulation period. You will also be earning interest on the amount
you would have paid in taxes during the accumulation period. Most states’ tax
laws on annuities follow the federal law. You should consult a professional
tax advisor to discuss your individual tax situation.
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Take Advantage of the “Free Look” Provision
Many states have laws that give you a set number of days to
look at the annuity contract after you buy it. If you decide during
that time that you do not want the annuity, you can return the contract
and get all your money back. This is often referred to as a free look
or right to return period. The free look period should be prominently
stated in your contract. Be sure to read your contract carefully during
the free look period.
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Is a Fixed Deferred Annuity Right for You?
You should think about what your goals are for the money you
may put into the annuity. You need to think about how much risk you
are willing to take with the money as well. Ask yourself the following
questions: How much retirement income will you need in addition to
what you will get from Social Security and pension? Will you need that
additional income only for yourself or yourself and others? How long
can you leave money in the annuity? Does the annuity let you get money
when you need it?
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Some Questions Your Agent Should be Able to Answer
A few questions that you should ask your agent are: Is this
a single premium or multiple premium contract? What is the initial
interest rate and how long is it guaranteed? What is the guaranteed
minimum interest rate? Can I get a partial withdrawal without paying
surrender or other charges? Is there a death benefit?
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Review Your Contract Carefully
Before you decide to buy an annuity, you should review the
contract. Terms and conditions of each annuity contract will vary.
Ask the agent and company for an explanation of anything you do not
understand. Do this before any free look period ends. Compare information
for similar contracts from several companies. Comparing products may
help you make a better decision. If you have a specific question or
cannot get answers you need from the agent or company, contact your
state insurance department.