Annuity Risks

An equity indexed annuity, is also known as an indexed annuity contract, is another alternative to the two primary types of annuities, a fixed annuity and variable annuities.

Instead of offering the fixed investment return of a fixed annuity or the variable investment return of a variable annuity, the equity indexed annuity offers a little bit of both. Like a fixed annuity, there is a minimum crediting rate guaranteed by the insurer, and, like a variable annuity there is a component of the product’s investment return that is linked to a specific equity index allowing for gains tied to an index ( NASDAQ, DOW JONES, RUSSELL )

This is how the income is generated through rising with the correlated gains of a market or index in which it is tied to. Annuity providers will typically offer a choice of indexes or markets to choose from. A equity indexed annuity product will generally offers a higher return than fixed annuities, but a lower return than variable annuities. Indexed annuities are quite close to variable annuities however, without the risk of losses. Many of these will have a floor ( Limiting any losses while protecting principal investment). In exchange for downside protection in the event the related index declines significantly in value, via the minimum crediting method the floor retains the principal and possibly the gains. Participant may have additional fees over and above the cost of a fixed or variable annuity. In addition, there are fees to cancel the contract if done to early in the maturation process of the annuity.

And finally, this type of investment is often difficult for participants to understand, as the method of calculating the indexed return is complicated and varies by insurer—everyone is different. Indexed annuities are growing quickly in popularity due to the safe money factor and lack of losses when nearing retirement. When you are ready to learn more and need to have a better understanding of the myriad of safe retirement options available to you be sure to schedule a conversation with The 401Kman

Annuities are often labelled as dangerous from one group or another's point of view. The first person or group is mentioned above, any advisor who is on a commission based plan, while the second typically tends to be someone who may have been a purchaser of one of those variable annuities. This is the downside of variable annuities the fact that like cars there are so many to choose from while all doing the same basic thing. Here used for retirement or cars to get from point a to b. This second person who is typically complaining about losses may simply have purchased a variable product after hearing and being inundated with annuity terms from a salesperson. Variable annuities are tied to investment indexes and may or may not have a floor to stop those losses. This person purchased in the Variable class of annuities and lost income after believing there was no possibility of loss like a fixed or indexed class of annuity. Many older style variable annuities have no floor as to losses while some newly introduced variable annuities can limit losses.

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I want to stress here not all variable annuities are bad and the following downside information is really based on years of dealing with annuities and the factors that don't come up in the initial conversations and purchase of annuities.

The biggest downside of an annuity is simply taking the time towards choosing the right solution for you from the many options and variables among them. Many annuity salespeople carry one or two carriers and are unfamiliar with the competition or not licensed in securities to provide variable annuities. It is very important to take the time to learn from an annuity specialist like the ones here at the 401K Man to learn the nuances between carriers, indexes, classes and distribution of annuities. There are also a few additional things to consider like the estate tax complexities and proper distributions after someones passing that we will also discuss below.

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If like most people you place money in a annuity it is for your retirement to grow the monies placed into it for future income. This is all fine and good until someone passes and the beneficiaries are not clear on the distributions. Distribution rules can vary from carrier to carrier. Many of the carriers or insurers also handle tax issues differently, and these interpretations often come into play after the death of the owner. The complicating factor with annuities is that much of the tax treatment is not covered by formal Treasury regulations regarding trusts besides the family possibly arguing over who gets what after an old annuity which may have had no clear lines of distribution or is simply outdated regarding beneficiaries is unearthed. 1035 exchanges have recently been approved according to the IRS for another resolution to an annuity after the annuitants passing in some circumstances.

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One of the first complications after death can be in valuing an annuity for estate tax purposes. Was it directed towards a trust? Holding annuities in trusts is generally a good solution for some however trusts as a beneficiaries do not always work well. Annuities are different than IRAs that can use see-through trusts to preserve a stretch IRA, but the relevant IRS rulings in this area do not apply to annuities, so insurers tend to follow the five-year rule for trusts that inherit IRAs. Entities and non-natural person owners, like a family limited partnership, will cause an annuity to lose its tax deferral. It is important to talk to a qualified estate planner and utilize whole life or universal life to fund the tax bill after death. Be sure to include any death benefit a contract may pay out in addition to the cash value. Ask for a “'date-of-death death benefit valuation'” to get an accurate value from the carrier for estate tax purposes on the annuity. A surviving spouse may also want to continue an annuity contract as an original owner, but they must be named as the beneficiary first. Oftentimes couples intend for the surviving spouse to get the annuity by setting the contract up with joint ownership, a spouse as annuitant and the kids as beneficiaries.This is one of the most common mistakes made by annuity agents, bypassing the surviving spouse in favor of the kids. Like IRAs, inherited annuities are subject to required distributions, but the rules are a bit different.There are different ways to do this and a qualified annuity specialist will guide you properly towards your goal.

The same government five-year rule for taking required minimum withdrawals applies, except that with annuities you have a hard-and-fast five years to take it out, not until the end of the fifth year as with IRA distributions.

And similar to inherited IRAs, annuity heirs might be able to stretch out payments based on their life expectancy. However depending on the insurer annuitant heirs may be required to do a “stretch” by annuitizing the contract. This means heirs lose control of the asset with new contracts that are turned into stretch annuities. There are a few annuity issuers that allow IRA-like withdrawals. Ask your annuity agent if heirs are allowed to take stretch withdrawals. Multiple beneficiaries can also impact stretches If allowed by the insurer, they may require multiple stretch beneficiaries to make withdrawals based only on the oldest heir's life expectancy. And other issuers won't allow a spouse to continue an annuity unless the spouse gets the entire balance.

For larger estates, keep in mind that annuities are income-in-respect to decedent assets, which means an heir could get a big tax deduction based on the pre-tax income inside of an annuity, assuming the estate paid federal estate taxes. Estate planning will vary greatly based on the skills of the planner but most will have set up a whole or universal life policy to cover the taxes.

We can offer many solutions based on your individual situation and needs after talking with you, there are many variables that come into play though. We welcome you to call or submit a request below.

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