One of the advantages of annuities is that they are tax-deferred. Tax-deferred means that you don’t have to pay taxes immediately, but you will pay them eventually.
Annuity Taxation Lawyers
What Is a Broad Annuity Definition?
An annuity is a financial instrument that can create long-term savings or retirement plans. The term “annuity” refers to your contract with an insurance or finance company. You agree to make a series of payments that will eventually be returned to you at some point in the future.
What Are the Different Types of Annuities?
There are several different kinds of annuities. The two main classes are broken down by how quickly they pay out: immediately versus on a deferred basis.
Deciding which one to choose will depend on factors such as how quickly someone wants to be paid out, their income goals, how willing they are to take risks, and so forth. As with most things, each comes with its advantages and disadvantages and may differ depending on what the insurance or finance company offers as part of their contract terms.
Fixed annuities are normally issued by insurance companies instead of financial firms. They are structured to provide a standard rate of interest, are relatively low cost, and are helpful for individuals seeking a predictable source of income for when they retire. There are usually no fees for fixed annuity plans, and they are the easiest to comprehend.
In contrast to fixed annuities, variable annuities will not payout every year. Rather, the funds will be invested into miscellaneous mutual funds and securities, which the insurance company will handle.
Although these can be structured with an attached rider that states the individual can receive a fixed income stream, they are generally formed without the rider and based on the stock market. Therefore, the amount disbursed will fluctuate. These are also associated with the highest fees, may have penalties for early withdrawal, and do not pay out regularly.
These provide a minimum standard income, but they also yield a fluctuating rate of interest based on stock market indices, such as the S&P 500. Yet, there is usually a cap on how much the individual can obtain if the market index performs well. Therefore, what could be a high return under variable annuities will be capped here. There also may be fees.
Immediate annuities offer the highest payouts. They operate similarly to life insurance policies. This works because the individual will hand over a large lump sum payment, which will then start to distribute about a year later. These policies work best for individuals willing to sacrifice funds upfront and look for a high-income stream later in life. Also, there are usually no fees associated with them.
Deferred annuities delay disbursements until over a year has passed. There are average fees connected to them and are usually offered by insurance companies. They are also more affordable since the insurance company will not have to return any payments immediately. The downside here is that the individual will have to wait until they start generating an income stream.
What Are Some Disadvantages of an Annuity?
An individual may come across several issues with annuities. While the advantages and disadvantages of annuities may depend on the individual and the annuity option they choose, several overall issues often arise with annuities.
In an emergency or other immediate need, a person will not have access to all of their funds. Therefore, even with an immediate annuity, a person cannot merely request to have all their funds returned. Also, if one of the plans has timed disbursements, then there will be high fees or penalties associated with any withdrawals that are made before they are due.
Significant commission fees and ongoing investment management fees are associated with all annuities. Those must be paid continuously until the plan is terminated or another circumstance rescinds the contract.
For the annuities that are capped or issue a portion to the insurance company for management fees, the person is not reaping the benefits they could get if they entered the stock market independently. Yet, this also means that their losses are not as high either.
Although no tax is imposed while the annuity accrues money, the disbursed funds will be taxed considerably.
Who Can Sell Annuities?
Annuities can be bought from either an insurance company or a financial investment firm. Annuities are generally regulated by two federal agencies: the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Therefore, regardless of whether the seller is an insurance company or financial firm agent, they must possess a license to sell annuities.
Some examples of places to buy annuities from include:
- Brokerage firms;
- Independent brokers or agents;
- Financial advisors;
- Large banks; and
- Mutual fund firms.
In addition, it is essential that an individual seeking to buy annuities conduct significant research on the companies or people with whom they plan to do business. Word-of-mouth referrals, online reviews, and dependable authorities (e.g., lawyers or accountants) are smart ways to vet a company or get referrals to a good company before buying annuities.
Who Can Buy Annuities?
Realistically, anyone who desires to buy an annuity can purchase one. However, they are much more valuable and prudent for some individuals than others.
For example, one type of person who may want to contemplate buying an annuity is a defendant in a personal injury case. The payouts can be used to pay off a judgment or make settlement arrangements with the case plaintiff.
Another individual who may want to invest in one is someone looking to retire or needs long-term care due to illness. The annuity provides a stream of income for them instead of working.
On the other hand, someone who is young and healthy may be better off investing directly with the stock market since they can still work and may not be able to make up-front, lump-sum payments yet.
How Does Taxation Work With Annuities?
To explain how taxes work with annuities, you must look at annuities as consisting of two parts. The first part is where you put money into the account, either in one lump sum or in installment payments, and allow interest to accumulate. You will not have to pay any taxes on any funds you have put into the account.
The second part is when you start obtaining payments from the insurance company after your money has accumulated interest over the years. A certain percentage of those payments will be taxed when you start receiving payments.
The amount you will be taxed will be based on the difference between the amount you put in and the amount you have earned that you can take out of the account. For instance, say that you put $10,000 into the account, and after years, it accumulated to around $25,000. You would be taxed on the $15,000 you earned in that period.
Who Should I Consult for More Advice on Annuities?
If you plan to pass this money on to family members or friends after you have passed on, you may want to consult an attorney specializing in estate planning. Your insurance lawyer will be able to further advise of the tax repercussions of annuities and the many other options you can choose to pass on money to beneficiaries.
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