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Annuities are contracts issued by insurance companies that allow investors the comfort of tax deferral on investment income until withdrawal. Most annuities can be withdrawn in periodic payments or taken in a lump sum, providing additional tax deferral opportunity. No taxes are paid on the interest accumulation in an annuity until money is withdrawn by the owner. This is allowed in order to promote individualized savings, thus reducing the need for government reliant during retirement. Since annuity dollars are invested on a tax deferral basis, annuities are primarily for long-term savings.

Different Types of Annuities:

Fixed Annuities
Deferred Annuities
Index Annuities

What Are Fixed Annuities?

Fixed Annuities are investment vehicles that earn a guaranteed rate of interest for a specific time period, such as one, three, five years, or 10 years. After the guarantee period has terminated, a new interest rate is set for the next period.

Fixed Annuities can be purchased in a number of ways by making a one lump-sum payment to purchase a single premium deferred annuity, or by making ongoing contributions to a flexible payment annuity. The flexible premium option allows you to make smaller payments over a longer period of time.

Since both the interest and principal are guaranteed, fixed annuities are similar to Certificates of Deposit (CDs) purchased from a bank. But, unlike a typical CD, an annuity is not backed by the Federal Deposit Insurance Corporation (FDIC); its security is directly related to the financial condition of the company that sells the annuity. This a good reason to always check the financial security of the issuing company.

A fixed annuity offers a current interest rate on premiums you contribute to your policy, along with a guaranteed minimum rate for the life of the policy. Typically, the current rate is higher than the guaranteed minimum, therefore, your money accumulates and compounds on a tax-deferred basis. You have several income options when you are ready to receive payments from your annuity and guarantees are based upon the claims-paying ability of the insurer.

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What Are Deferred Annuities?

Deferred Annuities are an excellent way to accumulate money for retirement, especially if you have several years before retirement. Since your money grows tax deferred it simply means you pay no taxes on earnings until you begin to withdraw your money.You can contribute to an annuity even if you have contributed the maximum to you IRA or 401k accounts.

With a deferred annuity your savings grow taxed-deferred and you postpone paying income taxes on any earnings until you actually withdraw money, which is typically during retirement, when you may be in a lower tax bracket.

If you happen to die while owning a deferred annuity, benefits will pass to your beneficiaries without the costs and delays associated with probate. The spouse who inherits an annuity prior to distribution has begun can step in as the new owner of the annuity without penalty.

When the time comes to start withdrawing your money, you have the option to take it all out in a lump sum or you can receive it in a steady income stream. This is known as annuitizing. When you start to receive periodic life payments (or life expectancy), in lieu of a lump sum distribution, income is guaranteed for life (or life expectancy) and the tax liability can be spread out over a period of many years. Some of the earnings included in each annuity payment are taxable. Meanwhile, tax-deferred earnings will continue to accumulate on the remaining principal and earnings that have not yet been distributed. So, receiving distributions as periodic payments after retirement may further reduce your income tax liability, if you are in a lower tax bracket. Click here to get request a free Annuity Quotation.

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What Are Index Annuities?

Until very recently, there were only two choices when it came to annuities: fixed annuities and variable annuities. But by the mid-90s, a third option was introduced that has started to gain in popularity: the index annuity.

Index Annuities were designed to mirror the performance of indices, such as the S&P 500, Russell 1000 Index, or the S&P 100. By following a popular index, index annuity owners can participate in general market changes, while being able to easily monitor increases and decreases in the annuity's value.

Issuers of index annuities always specify the level at which index annuity owners will be "in the market." This level is called the participation rate, and reflects how closely the annuity follows the index's performance.

Participation rates are quoted in terms of a percentage. If an index annuity has a defined participation rate of 80% when the index it follows goes up by 10%, the annuity's accumulated value increases by 8%. In many index annuities, the insurance company lessens the downside risk.

Many insurers state that no matter how the index performs, the annuity owner will never receive less than they originally deposited. Some institutions go one step further and even ensure that the annuity value will always increase in value by a minimum annual interest rate (usually 1-3%).

In order to pay for these promises, any annuity growth comes with a spread. The spread is the difference between what the annuity funds actually earn, and the amount that is credited. The annual spread can vary between 1.5% and 5.0%.

Index annuities are, at their very heart, an annuity. They are tax-deferred, meaning that you don't have to pay taxes on your gains until you actually make a withdrawal. Since they are meant to be used as retirement vehicles, they are designed to be held for the long-term.

Withdrawals made by an annuity owner under age 59 1/2 are subject to a 10% penalty by the IRS, as mandated by Congress. Excessive withdrawals made before the index annuity matures can also incur a fee or surrender charge levied by the issuing insurance company if annuity funds are withdrawn before the contract expiration date.

Since index annuities have become so popular more insurance companies have developed their own version so finding the right annuity can get confusing.

To help you sort through the confusion

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