31 August 2006
Deferred Annuity
Posted by selfprofit under: Annuity .
Deferred Annuity
The second usage for the term annuity came into being during the 1970s. This contract is more correctly referred to as a deferred annuity and is chiefly a vehicle for accumulating savings, and eventually distributing them either in the manner of an immediate annuity or as a lump-sum payment.
All varieties of deferred annuities owned by individuals have one thing in common: any increase in account values is not taxed until those gains are withdrawn. This is also known as tax-deferred growth.
A deferred annuity which grows by interest rate earnings alone is correctly called a fixed deferred annuity (FAs). A deferred annuity that permits allocations to stock or bond funds and for which the account value is not guaranteed to stay above the initial amount invested is correctly called a variable annuity (VAs).
A new category of deferred annuities has emerged in 1995, called equity indexed annuity (EIA). Equity indexed annuities may have features of both deferred annuities just described. The insurance company typically guarantees a minimum return for EIA. An investor can still lose money if he or she cancels (or surrenders) the policy early, before a “break even” period. An over simplified EIA rate of return is equal to the “participation rate” multiplied by a target stock market index’s performance excluding dividends. Interest rate caps, or administrative fee may be applicable.
There are two phases to a deferred annuity. The accumulation phase is the time between initial purchase and annuitization. The annuitization phase starts when the annuity is turned into a stream of payments. Before annuitization, the deferred annuity contract may allow the purchase of additional (premium) payments to the contract, increasing the contract’s value. It should be noted that less than 1% of deferred annuinties are annuitized by annuitants.
Deferred annuities in the United States have an advantage that all capital gains and income are tax deferred until withdrawn. In theory, this allows more money to be put to work while the savings are accumulating, leading to higher returns. A disadvantage, however, is that when a variable annuity is withdrawn or inherited the interest/gains are treated as ordinary income and are taxed as such.