Series: Saving and Investing

Page 1 of 2

Annuities: Your Private Pension Plan Terms of Use:

An annuity is a series of equal payments made to you (or which you make) over a specified period of time. Examples of annuities are: insurance premiums, student loans, car or mortgage payments, and retirement savings.

When you set up an annuity for your retirement, it’s like creating your own private pension plan. You can buy annuities from some banks, credit unions, insurance companies and stockbrokers.

Although there are several kinds of annuity plans, they each have two phases:

Phase One – You Pay. In the Accumulation Phase, you pay the insurance company so much a month for an agreed amount of time or give them a big lump sum (Immediate Annuity). Some people give the company all their savings.

Phase Two – You Collect. In the Pay Out Phase, the insurance company usually pays you so much a month when you retire until you die.

If you give the insurance company all your money in a lump sum and set up an Immediate Annuity, you can start receiving your “paychecks” immediately. Some people opt to get a lump sum when they retire instead of monthly payments.

The big advantage to an annuity is that you don’t pay taxes until the Pay Out Phase. Then you pay income tax on the annuity payments you'ye received. If you’re under 59½ years old, you’ll pay income tax plus 10%.

Unlike an IRA or employer-sponsored retirement plan, you can put as much money into your annuity as you want.

Before you buy an annuity, make sure you understand what you’re signing. Are you buying a fixed or variable rate annuity? A fixed rate annuity means the insurance company agrees to pay you a fixed amount of interest on your money for a certain period of time, usually one year. After that, the rate can fall, although most insurance companies will guarantee a minimum rate of interest.

A variable rate annuity means your money gets invested into sub-accounts, something like a mutual fund. Like a mutual fund,

Series: Saving and Investing

Page 2 of 2

Annuities: Your Private Pension Plan Terms of Use:

you take the risk that some investments might not perform well and that you’ll lose money.

Check over the other terms of the annuity. A surrender period means if you try to get money out of the account during that period, you’ll have to pay a fee. Usually the surrender period is seven years, but it can sometimes be for the entire time of the annuity.

If you sign up for a single life annuity, it means you are the only one who can get “paychecks.” If you die the first month, everything left in your account goes to the insurance company.

With a joint annuity, you get paychecks for your lifetime or for the term of the annuity. If you die early, your beneficiary (usually a spouse) gets the rest during his or her lifetime or for the term of the annuity.

With a life certain annuity, your heirs can inherit it if you die before the annuity is up.

Some people set up annuities with a charity (such as a hospital, church or university) as beneficiary when they die. This lets you give money to a charity, take an income tax deduction for part of the contribution, and receive an income stream for the rest of your life.

These types of annuities don't provide as much money to you in the pay-out phase because the charity wants to make certain that part of the money is left over for them to use when you die. The tax deduction is also not as high as if you gave the charity money directly.

Many experts do not like annuity plans because insurance companies can go out of business before the annuity is up. They look at the fees that the companies charge as a waste of money.

Before choosing an annuity, experts suggest you contribute the maximum amount to all your other tax-deferred investments, such as 401(k) plans and Roth IRAs.

See what you learned.