Accumulation phase - The period of time prior to annuitization.
Annuitant - A person who receives benefit payments from an annuity.
Annuitize - A method of receiving annuity benefits through a series of income payments for life or some other defined period of time.
Annuity - A contract with a life insurance company which guarantees an income for life or some other defined period in exchange for premiums you pay.
Back-end load - Company expenses that are charged at the time benefits begin.
Beneficiary - When provided in a contract, the person who receives benefit payments if the annuitant dies.
Contractholder - A person who pays premiums for an annuity. Often the same person as the annuitant.
Death benefit - A provision in certain annuity contracts that pays the beneficiary when the annuitant dies before the payout phase begins.
Deferred annuity - A contract that begins the payout phase at some future date.
Equity-indexed annuity - A contract that combines a guaranteed minimum interest rate with earnings linked to the performance of an external stock or bond index.
Fixed rate annuity - A contract that specifies your funds will earn a specified interest rate and guarantees a return on your premium.
Flexible premium annuity - A contract in which the amount of each premium payment you make can vary.
Front-end load - Company expenses that are charged at the beginning of a premium payment period.
Free look - A period specified in the contract (such as 10 days) during which you can decide whether to keep an annuity or return it for a full refund of your premium. Your free-look period is 20 days when you buy an annuity contract to replace one you already had.
Guaranteed interest rate - A minimum rate of interest specified in a fixed annuity. The actual rate the insurance company credits your contract at any given time may be higher but can never be lower.
Immediate annuity - A contract that begins the payout phase within one year after you pay the single premium.
Level premium annuity - A contract in which the amount of each premium payment you make stays the same.
Loan provision - A feature in certain annuity contracts that allows you to borrow up to a specified percentage of the value. Contract loans are usually subject to taxes.
Morality Tables - Statistics that project ones life expectancy based on many variables.
Payout phase (also called the annuity phase) - The period of time when benefit payments are being made to the annuitant.
Premium - The money you pay to fund an annuity contract.
Refund Annuity - Refunds part or all of the premiums paid if the insured dies before the start of the liquidation period.
Surrender charge - A fee the insurance company will charge you if you cash in (surrender) an annuity before the payout phase begins, or if you make a withdrawal larger than specified in the contract.
Variable annuity - Traditionally, a contract with no minimum guarantee (some newer products do include guarantees). Because the benefit amount depends on the insurance company's investment gains or losses, you share some part of the investment risk with the insurer.
Withdrawal privilege - A provision in many annuity contracts that allows you to withdraw an amount less than the surrender value, without paying a surrender charge. Any withdrawal may be subject to taxes and penalties.
So, how do you decide whether a deductible IRA or a Roth IRA belongs in your
retirement plan?
If your income is too high to deduct regular individual retirement arrangement contributions, the Roth IRA is
a great addition to your retirement savings.
Even if you can deduct your IRA contributions, the Roth has clear advantages, primarily
the fact that there's no mandatory withdrawal schedule to worry about and that money
in a Roth can go to an heir tax-free.
You also won't have to worry about tax-free withdrawals triggering extra tax on your
social security benefits.
What about the financial advantage of getting tax-free versus taxable withdrawals?
Believe it or not, there's no guarantee that -- when all else is equal -- the Roth
will beat the regular IRA. You need a crystal ball as much as a financial calculator to
know whether it makes sense to give up tax deductions today in exchange for tax-free
income tomorrow.
It really depends on what your tax bracket will be when you retire. If you're in a
lower tax bracket, the regular IRA will prove to have been a better choice; if you're
in a higher tax bracket, the Roth will shine.
Example:
Assume that you deposit $4,000 a year in a regular IRA and just $3,000 in a Roth --
because that's all the regular IRA really costs you if you're deducting
contributions in the 25% bracket.
Assuming the money in the accounts earns at the same rate, at the end of any period,
the spendable amount in the accounts will be identical.
Sure, the deductible IRA will hold more money. But you'll owe tax on withdrawals.
Assuming a 25% rate, the after-tax amount will be the same as the tax-free amount coming
out of the Roth IRA.
As noted, however, there is a way to give the Roth a big advantage. Put a full $4,000
into the account each year rather than a stunted $3,000, and increase your contribution as the limits rise.
But what if you find yourself in a lower tax bracket
in retirement? Then you might be kicking yourself for passing up regular IRA deductions back in the
bad old days of high income tax rates. Assuming there will still be an income tax when you
retire (a pretty good bet), how can you know whether you'll be in a higher or lower
bracket?
You can't. In the past, it was generally assumed that retirees would fall into a
lower tax bracket because they'd have less taxable income. Now, however, it's
increasingly likely that retirees will maintain their income levels.
Ironically, because opting for a Roth will reduce taxable income in retirement,
it's more likely that you'll be in a lower bracket (which is a minus for the
Roth); conversely, using a regular IRA will boost taxable income in retirement, possibly
pushing you into a higher bracket (which is a minus for the regular IRA).
The advantage of a Roth IRA over a regularly-taxed account is obvious.
Either way you pay income tax up front.
But with Roth, you're then done paying taxes; with a regular account you're just getting started.
The advantage of a Roth IRA over a deductible IRA is almost obvious:
-
Roth is simple: it requires no special reporting to the IRS. (With a
deductible IRA you have to report a deduction on your 1040 form when
you make a contribution; on withdrawal you report the entire withdrawal
amount as taxable income.)
- Roth is flexible: because you've taken care of
your tax obligations up front you tend to face fewer restrictions
later. (For example, you don't need to begin withdrawing your money by
a set age; with a deductible IRA you're required to start making
withdrawals by age 70½.)
-
Roth has an extra advantage if you think taxes will probably rise in the future, since you're paying now rather than later.
(Of course that's a disadvantage if you think taxes will fall.)
-
Roth has an additional, somewhat confusing advantage that it lets you shelter more real money:
the same dollar amount, but in post-tax, rather than pre-tax dollars.
To learn more about
Individual Retirement Arrangement
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Individual Retirement Arrangement (IRA)
Also known as Individual Retirement Account.A type of savings account for retirement. 1. Deductible traditional IRAs:
Special tax rules allow you to reduce your taxable income by your
qualified contributions to your IRA. You pay tax when you make
withdrawals from your IRA. 2. Nondeductible traditional IRAs:
Although you cannot reduce your income by the amount of your current
nondeductible contributions, you do not pay tax on the earnings of your
account until you make withdrawals. 3. Roth IRAs:
You cannot deduct current contributions to a Roth IRA, but when you
make qualified withdrawals from your account, you will not be taxed on
the withdrawals.
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Occasionally the question comes up about whether it makes sense to buy
a
variable annuity inside a tax-deferred plan like an
Individual Retirement Arrangement (IRA).
The first, income deferral annuity, is utterly irrelevant if the annuity is
held in an IRA or retirement account. The IRA and plan already
provides for the deferral and, in fact, distributions are governed by
the provisions of Section 72 applicable to IRA retirement plans, not
the general annuity provisions. I would go so far as to tell anyone
who has someone trying to sell them one of these products in a plan
based on the tax benefits to run as fast as possible away from
that adviser. S/he is either very misinformed or very dishonest.
The second, beneficiary designation annuity, is also a nonissue for annuities
in a retirement account. IRAs and qualified plans already provide for
beneficiary designations outside of probate, for better or worse.
The third, annuitization, is potentially valid, since that is one
method to convert the IRA or plan balance to an income stream. Of
course, nothing prevents you from simply purchasing an annuity at the
time you desire the payout rather than buying a product today that
gives you the option in the future.
I suppose it is possible that the options in the product you buy
today may be superior to those that you expect would be available
on the open market at the time you would decide to "lock it in" or
you may at least feel more comfortable having some of these
provisions locked in.
Finally, the fourth feature involves the actual guarantees that are
provided in the annuity contract. To take care of an obvious
point first: the guarantees are provided by the insurance carrier, so
clearly it's not the level of FDIC insurance that is backed by the
US Government. But, then again, only deposits in banks are backed by
this guarantee, and the annuity guarantees have generally been good
when called upon.
Normally, any guarantee comes at some cost and the cost should be
expected to rise as the guarantee becomes more likely to be
invoked. Some annuities are structured to be low cost, and tend to
provide a bare minimum of guarantees. These products are set up
this way to essentially, provide the insurance "wrapper" to give the
tax deferral.
I would note that if, in fact, the guarantees are highly unlikely to be
triggered and/or would only be triggered in cases where the holder
doesn't care, then any cost is likely "excessive" when the
guarantee no longer buys tax deferral, as would be the case if held
in a qualified plan. Note that the "doesn't care" case may be true if
the guarantee only comes into play at the death of the account
holder, but the holder is primarily interested in the investment to
fund consumption during retirement.
What this means is that you need a) a full and complete understanding
of exactly what promise has been made to you by the guarantees in the
contract and b) a full understanding of the costs and fees involved,
so that you can make a rational decision about whether the guarantees
are worth the amount you are paying for them.
It's theoretically possible to find a guarantee that would fit a
client's circumstance at a cost the client would deem resaonable that
would make the annuity a "good fit" in a retirement plan. Some
problems that arise are when clients are led to believe that somehow
the annuity in the retirement plan gives them a "better" tax deferral
or somehow creates a situation where they "avoid probate" on the plan.
A good agent is going to specifically discuss the annuitization and
investment guarantee features when considering an annuity in a plan or
IRA and will explicitly note that the first two (tax deferral and
beneficiary designation) don't apply because it's in the plan or IRA.