### All things you must to know about Annuities investment (Invest Safe)

**An annuity**is an

__investment sold by an insurance company that either promises a minimum rate of return to the investor or allows the investor to allocate payments to various funds that invest in the stock and bond markets.__These products offer regular payments for the rest of the annuitant's life, but owners of annuities can instead take money out as lump sums or random withdrawals on the back end. Annuities are part of the retirement plans of many individuals, and they can either be part of the safe-money piece or can provide exposure to the stock and bond markets.

The three main types of annuities are

**fixed**,**indexed**, and**variable.**

**- Fixed annuities**A fixed annuity promises a minimum rate of return to the investor in exchange for one big payment into the contract or several periodic purchase payments. The purchase payments are allocated to the insurance company's general account, so the rate of return is "guaranteed." But, that just means it's backed by the claims-paying ability of the insurance company's general account. So before turning over your money to an insurance company, expecting them to pay it back to you slowly, you might want to check their A.M. Best rating and their history of paying claims.

In a

**fixed annuity**, the insurance/annuity company bears all the investment risk. This product is suitable for someone who wants a safe investment, something that promises to make dependable payments for the rest of his life, no matter how long he ends up living. The fixed annuity offers peace of mind if not a high rate of return.

**- Indexed Annuities**A special type of fixed annuity is the

**equity-indexed annuity**or just**indexed annuity.**With this product, the investor receives a guaranteed minimum rate of return when the stock market has a bad year. But, he/she receives a higher rate of return when an index usually the S&P 500 has a good year.Do they receive the full upside, as if they owned an S&P 500 index fund? No, and that must be made clear by the sales representative. The contract is also not credited with the dividends associated with the S&P 500, and those dividends can easily be worth 2 or 3% of the index's total return for the year.

Equity indexed annuities have a participation rate. A participation rate of 70% means the contract gets credited with 70% of the increase in the S&P 500. If the index goes up 10%, the contract makes 7% ... unless that amount is higher than the annual cap.

Yes, these contracts also have a cap placed on the maximum increase for any year, regardless of what the stock market does. So, with a participation rate of 70% and a cap of 6%, what happens if the S&P goes up 20%? Although 70% of that is 14%, if you're capped at 6%, then 6% is all the contract value will rise that year. As you can see, indexed annuities are really about the downside protection, which is why a securities license is not required to sell fixed annuities, equity-indexed or otherwise.

**- Variable Annuities**Inflation is measured by the Consumer Price Index. Investors adjust the returns on their investments by the CPI to calculate their inflation-adjusted or real rate of return. If an investor receives 4% interest on her bond when the CPI is 2%, her inflation-adjusted return is just 2%. Take the rate of return and then subtract out the CPI to calculate real or inflation-adjusted return. If an investor receives just 1% when the CPI is 2%, his return would be -1% in terms of inflation-adjusted return. He is, in other words, losing purchasing power.

Unlike a fixed annuity, a variable annuity doesn't promise a rate of return. That's why it is called a "variable" annuity the return varies. In exchange for bearing the risks in the stock and bond markets, the variable annuitant gets the opportunity to do much better than he would have in a fixed annuity, protecting his purchasing power from the ravages of inflation.

Could he do worse? Yes, but if he wants a guarantee, he buys a fixed annuity where the insurance company guarantees a certain rate of return. Now he lives with purchasing power risk, because if the annuity promises 2%, that's not going to be sufficient with inflation rising at 4%. If he wants to protect his purchasing power by investing in the stock market, he buys a variable annuity, but now he takes on all the risks involved with that.

Variable annuities use mutual fund-type accounts as their investment options, called

__sub accounts__. In a deferred annuity, the annuitant defers taxation until he takes the money out, which is usually at retirement. The money grows much faster when it's not being taxed for 10, 20, maybe even 30 years, but every dance reaches the point where we must pay the fiddler. It's been a fun dance, for sure, but the reality is we will pay ordinary income tax rates on the earnings we have been shielding from the IRS all these years when we decide to get our own hands on the money.**Features of Annuities**

An annuity comes with a mortality guarantee, which means once it goes into the pay out phase, the annuitant will receive monthly payments for as long as he is alive (a mortal). The fixed annuity states what the check will be worth at a minimum, while the variable annuity well, it varies. In the variable annuity, the annuitant will receive a check each month, but it could be meager if the markets aren't doing well.

A fixed annuity is an insurance product providing peace of mind and tax deferral. A variable annuity is a mutual fund investment that grows tax-deferred and offers some peace of mind. But, whether it's fixed or variable, the insurance company offers a death benefit that promises to pay a beneficiary at least the amount of money invested by the annuitant during his life period. In a regular old mutual fund investment, we could put in $80,000 and when we die the investment could be worth $30,000, which is all our heirs would inherit. In a variable annuity, the death benefit would pay out the $80,000.

And, if the value of the investment was more than the $80,000 cost basis, the heirs would receive the $90,000 or whatever the account was worth. Note that in the variable annuity, this death benefit is only in effect while the annuitant is deferring any payments from the contract. As we'll see, once we flip the switch to receive payments in a variable annuity, well, anything can happen.

Insurance companies sell peace of mind. Both the mortality guarantee and the death benefit help a lot of investors sleep better. For maximum peace of mind, individuals should buy a fixed or indexed annuity. For some peace of mind and the chance to invest in the stock and bond markets, individuals should consider a variable annuity.

A variable annuity offers the investment choices from a family of mutual funds (growth, value, high-yield bonds, etc.), the tax deferral from an IRA or 401(k) plan, plus a death benefit similar to a life insurance policy. A fixed annuity—or indexed annuity—offers the tax deferral, the death benefit, and a dependable stream of minimum payments, even if the annuitant lives to 100.

**Purchasing Annuities**

The categories of fixed, indexed, and variable annuities refer to the way payments are calculated on the way out. In terms of buying annuities the two major types are

**immediate**and**deferred**. These terms refer to how soon the contract holder wants to begin receiving payments now, or later? These are retirement plans, so we do need to be 591/2 to avoid penalties. Therefore, some customers might want or need to wait 20 or 30 years before receiving payments. If so, they purchase a deferred annuity.The tax deferral is nice, but if the individual is already, say, 68 years old, he may want to retire now and start receiving payments immediately. As you can probably guess, we call that an immediate annuity while there are immediate variable annuities, it is more common to buy the fixed immediate annuity why? The whole point of buying an immediate annuity is to know that no matter what happens to social security and your 401(k) account there is a solid insurance company contractually obligated to make a payment of at least X amount for as long as you live. An immediate variable annuity would work out well only if the investments did while there is some minimal payment guaranteed, it is meager.

An immediate fixed annuity does not offer a high rate of return, but it does provide peace of mind to investors in retirement. Many financial planners would suggest at least some of their customers' retirement money be in a fixed immediate annuity maybe just enough to provide a monthly payment covering monthly expenses. Figuring withdrawal rates from retirement accounts is tricky, so having a payment of X amount from a solid insurance company could smooth out the bumps.

Customers can buy annuities either with one big payment or several smaller payments. The first method is called

**"single premium"**or**"single payment.**" The second method is called**"periodic payment."**If an investor has a large amount of money, he can put it in an annuity, where it can grow tax-deferred. If he's putting in a big single purchase payment, he can choose either to wait (defer) or to begin receiving annuity payments immediately. If he's at least 59 1/2 years old, she can begin the pay-out phase immediately. That's called a**single-payment immediate annuity**. Maybe he's only 42, though, and wants to let the money grow another 20 years before taking it out. That's called a**single payment deferred annuity (SPDA)**.Many investors put money into the annuity during the accumulation phase (pay-in) gradually, over time. That's called "periodic payment," and if they aren't done paying in yet, you can bet the insurance company isn't going to start paying out. So, if you're talking about a "periodic payment" plan, the only way to do it is through a periodic deferred annuity. There is no such thing as a

**"Periodic Immediate Annuity"**.So there are three methods of purchasing annuities:

**Single-Payment Deferred Annuity****Periodic-Payment Deferred Annuity****Single-Payment Immediate Annuity**

Again, variable annuities use sub accounts as the investment vehicles in the plan. But, annuities add both features and extra expenses for the investor on top of all the investment-related expenses. Tax deferral is nice. So are the death benefit and the annuity payment that goes on as long as the individual lives. But, that stuff also adds maybe 1.0-1.5% per year in expenses to the investor.

Variable annuities come with a free-look period, which is generally a minimum of 10 business days. If the consumer decides he or she doesn't want to keep the prod¬uct, he or she can cancel without losing any premiums or surrender charges to the company. For fixed annuities, consumers have the same free look period their state re¬quires of insurance policies.

**Receiving Payments (Settlement Options)**

Some investors make periodic purchase payments into the contract while others make just one big purchase payment. Either way, when the individual gets ready to annuitize the contract, he tells the insurance company which payout option he's choosing. And, he is not able to change this decision he makes the decision and that's that.

If the individual throws the switch to receive payments and chooses life only or straight life he'll typically receive the largest monthly payout. Why? Because the insurance company sets those payments and the insurance company knows better than he does when he's going to die. Not the exact day or the exact method, of course, but they can estimate it with amazing precision. Since the insurance/annuity company is only required to make payments for as long as he lives, the payments are typically the largest for a "life only" or "straight life" annuity settlement option. How does the individual win? By living longer than the actuarial tables predict.

If this option seems too risky, the individual can choose a "unit refund life annuity"

This way he is guaranteed a certain number of payments even if he does get hit by the proverbial bus. If he dies before receiving them, his beneficiary receives the balance of payments.

So, does the annuitant have family or a charity she wants to be sure receives the balance of her payments? If not, why not go with the life only/straight life option—tell the insurance company to pay her as much as possible for as long as she lives.

If she does have family, friends, or a charity she'd like to name as a beneficiary, she can choose a period certain settlement option. In that case, the insurance company must do what the name implies—make payments for a certain period. To either her or the named beneficiaries. For older investors, this option typically leads to a lower monthly payment, since the insurance company will now be on the hook for several years even if the annuitant conveniently expires. If it's a 20-year period certain pay¬out, the payments are made to the beneficiary for the rest of that period, even if the annuitant dies after the first month or two.

The annuitant could also choose life with period certain, and now we'd have an either-or scenario with the insurance company. With this option, the company will make payments for the greater of his life or a certain period, such as 20 years. If he dies after 2 years, the company makes payments to his beneficiary for the rest of the term. And if he lives longer than 20 years, they just keep on making payments until he finally expires.

Finally, the joint with last survivor option typically provides the smallest monthly check because the company is obligated to make payments for as long as either the annuitant or the survivors are alive. The contract can be set up to pay the annuitant while he's alive and then pay the beneficiaries until the last beneficiary expires. Or, it can start paying the annuitant and the beneficiary until both have finally, you know.

Covering two persons' mortality risks (the risk they'll live a long time) is an expensive proposition to the insurance company, so these monthly checks are typically smaller than either period certain or life-only settlement options.

**Variable Annuities: Accumulation and Annuity Units**

There are only two phases of an annuity, the accumulation period and the annuity period. An individual making periodic payments into the contract, or one who made one big purchase payment and is now deferring the payout phase, is in the accumulation phase, holding accumulation units. When he throws the switch to start receiving payments, the insurance company converts those accumulation units to annuity units.

In a fixed annuity, the annuitant knows the minimum monthly payment he can expect. A variable annuity, on the other hand, pays out the fluctuating value of those annuity units. And, although the value of annuity units fluctuates in a variable annu¬ity during the payout phase, the number of those annuity units is fixed. To calculate the first payment for a variable annuity, the insurance company uses the following:

**Age of the annuitant****Account value****Gender****Settlement option**

Health is not a factor there are no medical exams required when determining the payout. This is also why an annuity cannot suddenly be turned into a life insurance policy, even though it can work in the other direction, as we'll discuss elsewhere.

**AIR and Annuity Units**

As we said, once the number of annuity units has been determined, the number of annuity units is fixed. So, for example, maybe every month he'll be paid the value of 100 annuity units.

Trouble is, he has no idea how big that monthly check is going to be, since no one knows what 100 annuity units will be worth month-to-month, just like nobody knows what mutual fund shares will be worth month-to-month.

So, how much is an annuity unit worth? All depends on the investment performance of the separate account compared to the expectations of its performance.

Seriously. If the separate account returns are better than the assumed rate, the units increase in value. If the account returns are exactly as expected, the unit value stays the same. And if the account returns are lower than expected, the unit value drops from the month before. It's all based on the Assumed Interest Rate (AIR) the annuitant and annuity company agree to use.

If the AIR is 5%, that means the separate account investments are expected to grow each month at an annualized rate of 5%. If the account gets a 6% annualized rate of return one month, the individual's check gets bigger. If the account gets the anticipated 5% return next month, that's the same as AIR and the check will stay the same. And if the account gets only a 4% return the following month, the check will go down.

**The Separate vs. General Account**

An insurance company is one of the finest business models ever conceived. See, no one person can take the risk of dying at age 32 and leaving the family with an unpaid mortgage, a stack of bills, and a sudden loss of income, not to mention the maybe $15,000 it takes just for a funeral. But, an insurance company can take the risk that a certain number of individuals will die prematurely by insuring a large number of and then using the laws of probability over large numbers that tell them how many individuals will die each year with only a small margin of error.

Once they've taken the insurance premiums that individuals pay, they then invest what's left after covering expenses and invest it wisely in the real estate, fixed-income, and stock markets. They have just as much data on these markets, so they can use the laws of probability again to figure out that if they take this much risk here, they can count on earning this much return over here within only a small margin of error.

And, most insurance companies are conservative investors. That's what allows them to crunch numbers and know with reasonable certainty they will never have to pay so many death benefits in one year that their investments are totally wiped out. This conservative investment account that guarantees the payout on whole life, term life, and fixed annuities is called the general account. In other words, the general account is for the insurance company's investments. Typically, it is comprised mostly of investment-grade corporate bonds.

Many insurance companies also create an account that is separate from the general account, called the separate account. It's really a mutual fund family that offers tax deferral, but we don't call it a mutual fund, even though it's also covered by and registered under the same Investment Company Act of 1940. The Investment Company Act of 1940 defines a separate account like so:

__"Separate account" means an account established and maintained by an insurance company pursuant to the laws of any State or territory of the United States, or of Canada or any province thereof, under which income, gains and losses, whether or not realized, from assets allocated to such account, are, in accordance with the applicable contract, credited to or charged against such account without regard to other income, gains, or losses of the insurance company".__

When the purchase payments are invested in the general account, they are guaranteed a certain rate of return. When the purchase payments are invested in the separate account, welcome to the stock and bond markets, where anything can happen.

## Comments

## Post a Comment

It is important for me to know your opinion in this contact.

please feel free to contact me, If you have any questions about this article or any further questions.