An annuity is a contract between you and an insurance company, whereby you give the insurer your premium dollars, and in return, the insurer guarantees you certain benefits. While annuities are not life insurance policies, they are typically issued by life insurance companies and are considered insurance products. All annuities offer tax advantages, but they are all unique depending on the type of annuity product purchased.
Here’s a look at 9 distinct advantages available via the plethora of annuity products available.
1. Accumulation annuities offer a tax advantage when saving for retirement. When you make a deposit, your earnings are tax-deferred until you withdraw them, allowing your savings to compound quicker. Fixed-rate annuities pay a set interest rate for a predetermined term. A fixed indexed annuity offers more upside potential but less predictability. The interest rate used to determine payments fluctuates, depending on the annual return of an index such as the S&P 500. But the lowest you can earn annually is 0%, protecting you against any loss. Variable annuities offer even more opportunities to participate in market gains while deferring taxes, but there is no protection from losses.
2. Income annuities are available in both deferred and immediate varieties. They can be paid out for a set term, like 10 years, or for a lifetime, which is the more popular option. They act as longevity insurance, protecting contract holders from the financial risk of outliving their money.
3. A “1035 exchange” means that you can swap your current annuity contract for another to guarantee that your contract stays up-to-date with the latest and greatest benefits and rates.
4. An unnecessary life insurance policy can be traded in for an annuity. Many older consumers find themselves with a paid-up cash-value life insurance policy that they simply don’t need. Section 1035 allows you to exchange this policy for an annuity, tax-free.
5. Many varieties of annuities work well within an IRA.
6. If you are wanting to defer required minimum distribution (RMD) payments, consider a qualified longevity annuity contract, or QLAC. This is a specialty product designed to meet specific IRS requirements that allow you to skip the RMDs on assets in the QLAC. This is the only way you can legally delay RMDs for a portion of your IRA funds, keeping more tax-deferred money in your IRA longer.
7. On the contrary, if you’re 72 or older, an immediate annuity helps fulfill your RMDs and is a great way to get a guaranteed lifetime income. While an immediate annuity converts an asset to income efficiently, you no longer have cash value and you have very little flexibility to change the income stream once it starts.
8. If you name your spouse as your sole primary beneficiary, upon your death your spouse will typically have the option of filing a claim to take the distribution as a spousal beneficiary. They could also assume ownership of the annuity and continue the contract without a taxable event.
9. If you withdraw funds from annuity earnings before age 59 ½ you could be hit with a 10% IRS tax penalty plus ordinary income tax. However, there are a few exceptions. For example, if you purchase an immediate income annuity with a lifetime income payout, you can avoid such a penalty on qualified (IRA) or non-qualified funds.
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