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Saturday, November 28, 2009

Fixed Annuity Insurance - Things to Consider When Choosing the Best Annuity

By John C. Ryan

A fixed annuity may sound confusing at first but if you understand how a CD works at a bank, you have the basic knowledge for fixed annuities. Annuities have other features besides a rate guarantee that make it an interesting choice over a CD. There's a little more information to look at to see if this type of investment vehicle is right for you.

There are two different ways to used fixed annuities. The first is an immediate annuity. In this case, you take smaller equal payments over a set period. The time may be your lifetime, the lifetime of your spouse and yourself, a specific number of years or you can request a specific payment amount and let the company tell you how many payments it lasts. A deferred annuity does just as the name implies, defers the payment to a later date.

Annuities are for retirement money and receive tax-deferred growth. As with any retirement vehicle from an IRA to a pension plan, if you take the money out of a fixed annuity before age 59 in most cases, you pay a penalty. In this case, it's 10 percent of the growth. There are exceptions to this rule. Lifetime payments or payments that last to the age of 59 or for at least 5 years if you're between the ages of 54 to 59 . You or your family also doesn't have to pay IRS penalties if the owner/annuitant dies or becomes disabled.

Annuities also have penalties imposed by the companies. These are surrender charges. A surrender charge is a percentage that normally decreases the longer you hold the annuity. They often start between ten and four percent with the percentage decreasing over a five to ten year period. However, some contracts may have as high as a fifteen percent surrender charge that never goes away unless you annuitize the payment.

There are exceptions to the surrender charge. Many contracts offer the ability to remove funds of as much as ten percent without penalty. This amount may be available each year or once for the life of the contract. Almost every annuity allows you to take the interest penalty free each year and some people use the annuities that way, just as they'd use a CD.

Even though you may allow your CD to roll over, you still have to pay taxes on any interest you earned. This isn't true for an annuity. As long as you don't remove the money from the contract, you don't have to pay taxes on the interest. Even if you want to take some of the principal and leave the interest in the contract, the IRS looks differently at your distribution. Annuity tax laws use LIFO rules. That means, last in, first out. Interest is always the last thing into the contract so the IRS considers the initial money you take as interest until you reach the amount you originally invested.

Immediate annuities have different tax rules. If you use the fixed annuity as a deferred annuity and then annuitize it later, it follows these rules also. Part of the payment each year is principal and part of it is interest, according to the IRS regulations.

The calculation comes from your life expectancy and the amount you'll receive in payments over that lifetime. If you make an initial deposit of $100,000, with a life expectancy of 25 years and annual payment of $10,000, you'll make $250,000 (25 times $10,000) with $150,000 over your initial investment. Simply divide the initial investment of $100,000 by $250,000 and you'll get the exclusion rate of forty percent. That means you only pay taxes on $6,000 each year. If you've had the money in the fixed annuity and have big gains, it pays to spread it out over several years.

There are great reasons to select fixed annuities over bank CDs, but most financial planners suggest you use both types of investments and diversify your funds. This is the safest method of investing in the event of unforeseen disasters. Most people find that the annuity is a great method of establishing an income they'll never outlive or a way to achieve tax-deferred growth to pass on to their children. - 23208

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