Find out what an annuity is, how an annuity invests money, and the pros and cons of buying an annuity.
Money Girl
186 MG What Is an Annuity and How Does It Work?
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Contact us before canceling entire account to continue bill credits to credit stop and bounce and required finance agreements do. Hi everyone and welcome back to Money Girl's Quick and Dirty Tips for Richard Life. I'm Laura Adams. The disappearance of workplace pensions and the volatility in our financial markets have put annuities in the spotlight as a potential solution for retirees. In this podcast, I'll cover the basics of annuities in plain English. In its simplest form, an annuity is an agreement in which you make one or multiple payments in exchange for receiving a set amount of income for a period of time. They've been around a long time and are commonly used by conservative retirees who want to make sure that they'll have a regular income for the rest of their lives. Even though annuities are a way to invest money, they're actually an insurance contract and therefore are only sold by insurance companies. Money that's held in an annuity can be invested in three basic ways and are either called fixed, variable or indexed. A fixed annuity pays out a fixed rate of return on your money. It's a guaranteed predictable income stream no matter what's going on in the financial markets. A variable annuity pays out a variable rate of return on your money. The income stream usually has a minimum guaranteed amount but can increase depending on the performance of the underlying investments that you select, such as stocks or mutual funds for instance. And an indexed annuity pays out a rate of return on your money that's tied to an economic index, such as the S&P 500. It's considered a hybrid of the fixed and variable types because you receive a minimum guaranteed payment but can also enjoy a higher return when there are gains in the broader market. In addition to annuities having different investment options, there are also a number of different kinds of annuities. Annuities are classified in a variety of ways and are segmented by features such as the way you pay premiums, when you start receiving income, the length of time you receive income and tax status. The variety of all the features and options can make understanding annuities a little challenging but I'm going to make it easy. Let's start with the two broadest annuity categories, immediate and deferred. An immediate annuity provides income right away or at least within a year after you buy it. You plunk down a big lump sum payment which is also called a single premium and start receiving an income stream from that money each month. For example, let's say you receive a life insurance payment of one million dollars after taxes and you want to create a monthly income from investing that money in an annuity. At immediateannuities.com, you can see what your monthly payment would be based on your age and gender. If you were a 40 year old female, for instance, a one million dollar annuity would give you about forty four hundred dollars a month right now. The other broad category of annuities is a deferred annuity, where you receive income at a future date. You make one or multiple contributions during the annuities savings phase and then receive income either as periodic payments or as a lump sum during the distribution phase. So it's similar to a retirement account where you set money aside that you access in the future. In fact, you can own a deferred annuity inside of a retirement account, such as a traditional IRA, 401(k) or 403(b). If you own an annuity inside of a retirement account, it's called a qualified annuity and it's subject to traditional retirement account rules. You know the drill. You contribute pre-tax dollars which are subject to the annual limits set by the IRS, which is five thousand dollars for 2010. Not only can you deduct your contributions from your taxable income in most cases, but you also defer paying taxes on the annuities earnings each year. You pay taxes on the money when you make withdrawals after age 59 and a half. With a qualified annuity, you must begin taking distributions no later than age 70 and a half. I love learning and anything that makes learning easier. If you're a parent and your child needs some homework help, then Ixcel is a right for your family. Ixcel is an online learning program for kids covering math, language arts, science, and social studies. Ixcel has interactive practice problems for topics from pre-k to 12th grade and everything is organized by grade and subject. As kids practice, they get positive feedback, awards, and explanations for wrong answers. Ixcel figures out what your kids need more help with and recommends more topics to practice. Their videos, lessons, sample problems, and learning games, too. 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Listen now by visiting morganstandley.com/invested at work or stream on Apple or Spotify, because we believe that when employees thrive, your company thrives too. Again, visit morganstandley.com/invested at work to listen today. Now, let's talk about the rules for either an immediate or a deferred annuity when you own it outside of a retirement account. That's called a non-qualified annuity. With a non-qualified annuity, you must contribute after tax dollars. There are no annual contribution limits, so you can put in as much money as you like. Even though you pay taxes on your contributions to a non-qualified annuity upfront, you defer paying taxes on their earnings until you take withdrawals after the age of 59 and a half. And unlike a qualified annuity that's held inside of a retirement account, you don't have to start taking distributions at any particular age. You may notice that these rules sound similar to a Roth account, but don't mix up the two. A Roth is a tax-free retirement account with annual income and contribution limits. A non-qualified annuity is not tax-free. You must still pay tax on your earnings when you take out distributions. A non-qualified annuity might be a good solution when you're able to max out all of your tax-advantaged retirement options, such as a workplace retirement plan and an IRA, and you still have money left over to sock away for retirement. So, what I'd like you to remember is that a deferred annuity acts a bit like a retirement account even if you don't own it inside of a retirement account. You enjoy tax-deferred growth until you take withdrawals after the age of 59 and a half. Early withdrawals from any kind of annuity are generally subject to income tax plus a 10 percent penalty. Some annuities also charge an additional penalty called a surrender charge for taking an early withdrawal. On the blog at moneygirl.quickanddirtytips.com, you'll find some additional information. I'll include eight pros and eight cons to investing in an immediate annuity and how you can assess the strength of an insurance company that sells annuities. There's a lot more to consider when it comes to annuities such as taxes and estate planning. So, I recommend that you consult with a qualified fee-only financial advisor about whether buying an annuity fits into your long-term financial strategy. I want to thank everyone who's downloaded a moneygirl audiobook or ebook and encourage you to submit a review wherever you bought it. You can get the audiobooks, moneygirl's guide to retirement planning and 10 steps to a debt-free life at audible.com or in the iTunes store. And if you prefer reading, 10 steps to a debt-free life is also available as a Kindle ebook on amazon.com. I'm glad you're listening. Cha-ching! That's all for now. Courtesy of Moneygirl, your guide to our richer life. Curious how equity compensation can help build employee financial confidence and move your business forward? Tune in to the latest episode of Morgan Stanley at Work's Invested at Work podcast, where we explore the power of financial benefits and how they can help your employees in the workplace and beyond. Listen now by visiting morganstandley.com/investedatwork or stream on Apple or Spotify. Because we believe that when employees thrive, your company thrives too. Again, visit morganstandley.com/investedatwork to listen today.