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Beneficiaries
Annuity contracts allow the owners to name beneficiaries. One of
the reasons that annuities are attractive to investors is because they
have a built-in death benefit. Just like the EIA has a minimum
guaranteed value, an annuity contract states that if the value of the
contract is less than the original premium, minus any withdrawals
or loans, the owner’s beneficiary upon the owner’s death shall
receive the original premium amount. However, if the annuity is
valued at more than the original premium amount, the beneficiary
will receive that larger amount. For example, James Client invests
$100,000 in a deferred variable annuity. Four years later, Mr. Client
dies. Prior to his death, he hadn’t taken any money out of the annuity.
His beneficiary for the annuity, his daughter, claims the annuity,
which is now valued at $89,000. Because Mr. Client hadn’t
taken any money out of the annuity, his daughter receives
$100,000—the original premium amount.
Original lump-sum premium = $100,000
Withdrawals = $0
Value of death = $89,000
Beneficiary receives = $100,000
(All amounts are hypothetical.)
Original lump-sum premium = $100,000
Withdrawals = $0
Value of death = $122,000
Beneficiary receives = $122,000
(All amounts are hypothetical.)
If the beneficiary of the annuity owner is the surviving spouse,
that person is entitled to treat the annuity as his or her own under the
current tax law. The spouse would become the new owner of the
annuity.
Recently, annuity issuers have come up with different ways to
calculate the minimum guaranteed death benefit, which help out the
owner’s beneficiary. One example is the reset death benefit, which
has a five-year standard. So, using our previous example, if Mr.
Client invests his $100,000 in the variable annuity on July 1, 2001,
the value would be reassessed on July 1, 2006, again on July 1, 2011,
and so forth, for the life of the contract as long as Mr. Client didn’t
annuitize it. The highest of these amounts, including the original premium,
becomes the new guaranteed death benefit. The benefit can
always go higher, but not lower.
Another calculation method for the death benefit is a step-up or
ratchet basis. The step-up basis works the same way the reset death
benefit does, except instead of waiting five years between reevaluations,
there is only a one-year wait. Therefore, the value of the contract
would be reassessed on July 1 of every year, rather than every
five years. Some variable annuities that offer the step-up basis do so
on a quarterly time frame, thus increasing the chance of an even
higher death benefit.
Finally, some insurers offer a certain escalation of death benefit
amounts, which may be three to five percent per year. This type
of “roll-up” death benefit works this way: When the annuity owner
dies, the beneficiary receives the greatest amount of either the
total premium paid, the current contract value, an assumed three
percent annual return, or the top death benefit on a specified
anniversary date.
“Roll-up” death benefit:
Original premium = $100,000
Contract value at death _$137,000
Assumed 3% annual return on contract = $112,550
Death benefit on July 1, 2003 (specified anniversary date) = $109,000
Beneficiary receives _$137,000
Be sure you know which type of death benefit your contract
allows. That way you’ll have an accurate concept of what to
expect. Plus, the annuity contract may specify that the death benefit
not exceed a certain amount, age, or percentage of the original
premium.
Loans and Withdrawals
Annuities may also allow for loans or withdrawals by their owners.
However, for those owners who wish to take out a loan against their
annuity (or just withdraw money) and who haven’t reached age 591/2,
there will be the 10-percent IRS early withdrawal penalty. There are
some exceptions to this rule, though. Individuals may take substantially
equal periodic payments in the case of the owner’s disability or
death, or for the purchase of an immediate annuity.
Exchanges
The IRS also allows for a tax-free exchange of nonqualified annuities
(i.e., those not within an IRA). This is known as a 1035
exchange, and must be from one annuity to another. Should the
owner be dissatisfied with the internal subaccounts, service, or performance
of the annuity, he or she will be able to exchange it for a
different annuity. This works not only from annuity to annuity within
one company, but also across different companies. However, there
may be some surrender charges for the older annuity.
Many times, the annuity owner differs from the annuitant. I’ve
seen this happen when the wife’s trust owns the annuity, but the
annuitant is the husband. It’s the annuitant whose life expectancy
determines the timing and amount of the payouts, should the annuity
be annuitized.
Annuities Not Held by Natural People
Annuities may be held by entities, rather than natural people. However,
for tax purposes, any deferred annuities would not be treated as
annuities and, thus, wouldn’t be tax-deferred. Any gain made on the
annuity would be taxed to the owner as ordinary income. This
includes any annuities held by corporations, charitable remainder
trusts, and certain other entities. This doesn’t include annuities held
by an estate because the owner has died, any annuities held by trusts
or other entities acting on behalf of a natural person, annuities within
qualified retirement plans, tax-sheltered annuities, or IRAs and
immediate annuities.
Expense Charges
Annuities, both fixed and variable, may have a management or
expense charge associated with them. This charge is levied by the
insurer and is an annual fee, which is usually billed on a quarterly
basis. These charges can be contract charges, which generally are fixed
for the life of the contract, and operating expenses, which may vary
from period to period. Contract charges protect the insurer from excess
mortality and expenses charges, which may include administrative and
sales costs, risk charge for death benefits, and insurer profits. The
operating expense charge covers the cost of investment management
fees and administrative costs of managing the particular subaccount
funds available. Fees vary from annuity to annuity and between companies.
All applicable fees will be disclosed in your annuity contract.
Surrender Charges
Finally, annuities will have some sort of sales or surrender charge.
This can be an up-front sales charge or a back-end load. If the insurer
deducts a charge when the premium is paid, thus resulting in a lower
amount of money being invested, this is a front-end load. However,
insurers generally impose a surrender charge, rather than charge the
investor up front. Surrender charges are generally charged only if the
owner takes more than 10 percent of the annuity value out during a
calendar year for the first few years of the annuity contract, like 7 or
10. Many variable annuities allow you to take the earnings out, which
may be a larger number than 10 percent. Surrender charges are levied
on a declining scale basis. For example, you purchase an annuity for
$100,000. This annuity’s surrender charge schedule is for 10 years.
After the tenth year, you would be able to draw out as much of the
contract’s value as you wished. This is actually a contingent deferred
sales charge, since it isn’t levied unless you pull out more than the
allowable maximum. More commonly, though, it is called a “back-end
load.” Back-end loads are designed to discourage the annuity owner
from transferring his or her money to a different company, or taking it
out altogether. There are some insurers who don’t charge any type of
sales charge. These annuities are akin to no-load mutual funds.
HOW ANNUITIES WILL HELP
Annuities are great for investing your after-tax dollars on a taxdeferred
basis. Think about it. If you could put away money and then
not be taxed on the growth, might your overall nest egg grow faster?
Annuities help people shelter their money from the government for a
time, even if it is a limited time. Plus, for annuities outside an IRA,
there is no limit to the amount of money that can be sheltered. Annuities
inside an IRA are subject to the regular contribution limits.
Annuities also provide a level of comfort for people who are concerned
that they may outlive their money. They also provide a good
way to help your money grow tax-deferred. Another advantage to
annuities is the guaranteed death benefit. The disadvantages associated
with annuities are the internal expense charges, surrender
charges, and the possibility of limited subaccount fund availability
within variable annuities. While annuities sound like a great investment,
they’re not for everyone. Be sure the annuity you decide on is
in line with your financial goals and objectives. |
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