Annuity Basics

My attorney suggested I consider an annuity.  Can you explain some basics about annuities?

I read an interesting article in a professional publication that I think did a good job explaining the basics so I’m going to draw from the writing of NAELA Attorney Lori Parker in answering your question.  Much like dogs come in different breeds, such as poodles and labs, either can be wonderful pets if matched with the right person and situation.  Without knowing much more than a dog has four legs, the adoption of a “cute pup” from a less then reputable breeder could end in owner distress.  Likewise buying an annuity requires checking out the financial or insurance person selling you the product and knowing some of the basics features of the annuity product to look for.

Types of annuities:

Commercial vs. Private:  Commercial annuities are insurance products.  Private annuities are typically contracts between family members, often used in a very narrow set of circumstances as a way to transfer a business between generations.  Both types can be used for Medicaid planning.

Fixed vs. variable:  A fixed annuity provides a guaranteed income in periodic payments.  A variable annuity is completely or partially based on the performance of the underlying investments.  Often the stock market.

Immediate vs. Deferred:  Immediate annuities usually have a single premium and must provide payouts in substantially equal amounts starting in less than one year from the date of purchase.  Deferred annuities may allow investment over a period of time.

Qualified vs. non-qualified:  The difference here is due to the taxability of deposits and withdrawals.  Qualified annuities are part of tax-deferred retirement plans like 401k, 403b and IRA accounts.  They have been funded with pre-tax dollars or rollover funds from these kinds of accounts.  Qualified annuities are subject to contribution limits, early withdrawal penalties if taken before age 59 1/2 and subject to minimum required distributions after age 70 ½.  The withdrawals are taxed as ordinary income on the full amount of payouts.  If an annuity does not meet these requirements it is not qualified.  Non-qualified annuities are funded with after-tax dollars and therefore the periodic payments are taxed only on the income realized on the investment.  Mandatory withdrawals are not required at age 70 ½.  Sometimes the sellers of the annuity restrict the amount that can be deposited annually, but there is no federal limitation.

All annuities will have a combination of these basic types.  As you can see one size does not fit every one.

As an elder law attorney I don’t sell annuities or dogs, but I often discuss the use and need for annuities to help clients catch up on retirement planning, look at realigning investments to cover additional concerns like long term care costs or voice concern over the financial risk a client is facing due to their earlier investment choices that now don’t perfectly match their needs.     A single premium immediate annuity (SPIA) can help in several situations such as when a couple is downsizing from a house that is fully paid for, to a condo or rental because of age, physical or mental status reasons.  This kind of annuity transforms a lump sum cash asset into a stream of income.  Generally these are fixed annuities.  For Medicaid purposes an SPIA must be actuarially sound based on the claimant’s life expectancy, irrevocable and payable on death to the local Medicaid agency as a remainder beneficiary.  These are used in some situations to convert non-exempt assets into a permissible Medicaid exempt income stream.  Consult with a knowledgeable professional before purchasing.

Some annuities factor a death benefit into their contracts.  Therefore one question every person should ask is can this annuity be passed along to my beneficiaries?  Other questions are: (1) What are the tax consequences to me as I make withdrawals and what are the tax consequences to the future beneficiary?  (2) Will this annuity deplete my financial assets so I can’t handle a sizeable emergency?  (3) How much are the sales commissions and other fees?  And (4) Are there any penalties for early withdrawal?


Disclaimer: Information contained in this column is meant to be of general information on frequently asked questions regarding disability, elder law, estate planning and probate law, and is not specific legal advice to a client.  No attorney-client relationship is created by reading this column.

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