An annuity is a contract in which a purchaser pays either a lump sum or makes a series of contributions to an annuity account with a life insurance company. The amount in the annuity account is then converted into a lifetime stream of income for the purchaser.In an immediate payout annuity, the income payments to the purchaser begin almost immediately. In a deferred payout annuity, the payments do not begin until a later date and the purchaser continues to make contributions to allow the account balance to grow tax-deferred. Even if you do not qualify for certain retirement account contributions due to income limits or already made the maximum annual contributions, you may be able to gain the benefits of tax-deferred growth with an annuity.
In a fixed annuity, the purchaser receives a fixed rate of interest as a return on his investment in the annuity. In a variable annuity, the investment contributions may be invested in a wide array of investments including stocks, bonds, and money markets, so the purchaserís return on investment is variable, although some variable annuity contracts guarantee a minimum rate of return.Annuities are often purchased by seniors or retirees living on a fixed income, such as social security, as a way to supplement their income. See issues facing seniors. Because insurance companies can spread the risk among the large group of annuity purchasers, you can sometimes receive a higher monthly income payment from an annuity than from a self directed IRA or 401k account.
What Happens to Annuity When You Die?
If you are investing in a deferred annuity and die during the accumulation phase, meaning you have not begun to take withdrawals yet, your beneficiary will inherit the entire amount of your investment in the annuity. Interest earned on annuities is tax-deferred until withdrawn. After your death, your beneficiary will pay tax on any investment gains in the account. If your beneficiary chooses to receive income for life from the annuity, he or she will pay ordinary income tax on the portion of the payments that represents the gains or earnings on the original amount invested.An important consideration in estate planning is whether an asset will be included in your gross estate and therefore subject to estate taxes. Whether your annuity is considered part of your estate for estate tax purposes may depend on whether you own a straight life annuity or a survivorship annuity. If you are concerned about estate taxes, consult your tax professional for more information.Annuities can be used in charitable giving, especially if estate taxes are a concern. If you own a deferred annuity and will not need the income, you may name a charity as the beneficiary of the annuity.If your estate plan includes a pet trust to provide for your pets after your death, you may name the pet trust as beneficiary of your annuity to fund your pet trust. Check with the institution from whom you purchased the annuity to confirm they will accept the pet trust as a beneficiary on your account.When you purchase an annuity, you receive a lot of paperwork outlining the terms and conditions of your investment, including information on what your heirs and beneficiaries may receive. Confirm that you have designated a primary and contingent beneficiary or alternate payee on your account. Annuities can be very complicated. If you purchased an annuity from a salesperson or financial advisor, you may have felt like you were rushed through the annuity paperwork with little chance to review or understand it. When working on your estate plan, make sure you review the annuity paperwork again to ensure you understand the death benefits or beneficiary provisions.
Before You Buy an Annuity
Before you purchase an annuity, get detailed information on how the person selling it to you will be paid. Think carefully about the compensation your financial representative may be paid to get you into an annuity. In 2018, regulatory changes went into effect imposing a fiduciary standard for certain investments. Before you sign an annuity contract or make changes to your existing annuity, make sure you are well informed. Don't rely solely on information provided by your financial advisor. Do your own independent research and carefully review the current rating of the insurance company issuing the annuity.
Benefits of Owning an Annuity
The benefits of an annuity depend on the specific contract terms of the annuity you purchase. Because there are so many types of annuities, the benefits of an annuity vary. Here are some benefits an annuity can provide:1. Guaranteed income for life.2. Contributions to an annuity grow tax-deferred.3. If the annuity features a death benefit, you can pass the death benefit to your designated beneficiaries directly and avoid probate.4. If you purchase a joint life annuity or joint and survivor annuity, you can provide income for life to your spouse, partner or another joint payee.5. If you purchase a variable annuity, you can invest your account in many different types of investments.6. You can avoid probate with an annuity by naming beneficiaries of your choice, including children, grandchildren, a living trust, special needs trust or a charitable organization.
Annuity to Support Spouse or Child
Annuities are sometimes used in estate plans to provide income for life for a spouse, adult child or other beneficiary that is not good at managing money. An annuity can be purchased for the beneficiary rather than giving him or her access to a large sum of money at one time. This may also be a good idea if the beneficiary has creditors that would place a claim on any gifts or inheritances the beneficiary receives. If you are considering leaving money to your spouse, children or grandchildren, this is one way an annuity can be used in estate planning in a manner similar to a trust.However, one disadvantage to using annuities as a form of spendthrift trust is the beneficiary will only receive a fixed monthly payment from the annuity and cannot access a large lump sum at one time. If the beneficiary needs access to a significant amount of money to pay for medical treatments or a health care emergency, he or she would not be able to tap into the annuity. If you want the principal to be available for these types of emergencies, an alternative is to set up a trust for the beneficiary and have the trust managed by a trustee. The trust document can be drafted to give the trustee discretion to tap the trust for health care emergencies, college funds or other important expenses of the beneficiary.
Annuities and Medicaid Planning
If you may need to qualify for Medicaid to pay for long term care, consult an estate planning lawyer before purchasing an annuity. This is also important if you are creating a Miller Trust. To the extent you have an interest in an annuity at the time of your death, or remaining annuity payments are owed at the time of your death, the annuity may be subject to estate recovery by Medicaid because it could be considered an asset of your estate. Learn about the ramifications to your Medicaid eligibility before you buy an annuity. See Medicaid Planning and Medicaid Annuity.
Special Needs Trusts and Annuities
If you established a special needs trust for your child, one option for funding it is by naming the special needs trust the beneficiary of your annuity. By directing the payout from the annuity to the special needs trust, it prevents your child from receiving a lump sum inheritance that could impact your childís eligibility for Medicaid. For more information, go to Medicaid for children.
Where to Keep Annuity Papers
Put information on your annuity in a file with your other investment information that can be located by the executor of your will, the trustee of your living trust or the agent under your durable financial power of attorney. Review our Estate Plan Checklist for more information.
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