Investment Strategies

An annuity can seem like it’s some word thrown around with retirement and savings on financial ads during football season. Here’s a little help to understand annuities.

Annuities are essentially a savings account that you get from an insurance company. They are set up to ensure that you have money for retirement and can help you stretch money over a couple of decades.

Usually, annuities are bought through, or along with, a life insurance policy. Common knowledge around life insurance is that it helps you make sure your loved ones are taken care of financially if you were to pass earlier than hoped. Conversely, an annuity is a policy that helps ensure you are taken care of should you live longer than you’d thought you would.

Taxes on annuities are deferred until they are paid out. What’s good about this is that there is more money to gain interest from than an investment that can be taxed. It’s important to note that annuities are invested in heavily up front. Then payments are made to you periodically. The payments can be made to you until you pass.

If you live out your life expectancy, an annuity can be an appropriate investment. However, if you were to go too early, an annuity may not be the best investment.

Why an annuity may be right for you

An annuity is practically the definition of long-term investment and almost strictly for that purpose. Also, it guarantees a  steady income for life.

One thing that makes it a long-term investment is the steep penalties for withdrawing finds too early. A ten percent tax can be charged on funds taken out before you reach the age of 59.5. Although, depending on how much the annuity has accumulated, it may be somewhat worth it. Note that the 10% penalty will only be applied to the return on the investment. The thinking is the money you put in was already subjected to taxation.

An annuity can be used for a child’s higher education however, when it’s time for them to use it, they can use it for whatever they want—not just education.

Annuities Options

Single-Premium
The name says it all in this one. You buy the annuity up front in one single payment. Single premiums usually require a minimum of around ten thousand dollars.

Immediate
Immediate annuities trigger payments to you as soon as the annuity has fully vested. Usually from a single-premium annuity. Typically, these annuities as well as single-premium annuities are purchased when a retired individual gets their retirement funds in a lump sum. They then take these funds and purchase an annuity. In the annuity it collects interest and creates a steady and dependable income.

Flexible-Premium
Basically the same as a single premium but breaks the payment up into a series of payments.

Deferred
A deferred annuity doesn’t start payments until way down the road and may come in the form of a lump sum or may come in the form of the typical guaranteed payments that are made periodically.

Fixed
This is a low-risk annuity along the lines of a Money Market account or a CD. The interest yields around 3-5% and the rate is guaranteed for an agreed upon amount of time. The money you invest is usually invested by the insurance company in safer investments such as bonds. This usually looks more lucrative when rates are low but when rates go up in a higher risk investment, that’s money you’re missing out on.

Variable
Essentially, the opposite of the Fixed annuity. This is a higher-risk investment—more along the lines of a mutual fund, which usually carries a growth rate of 12%. Also different from the fixed annuity is the Variable has no guarantee of interest or principal. Variable annuities are still appropriate for long-term investment.

Annuities and Taxes

Whether or not your annuity is a qualified annuity will determine how your payouts are taxed.

An annuity is qualified when it used as a means to fund a retirement plan like a Roth IRA or a 401k. The money you invest is not subject to taxes when withdrawn. Also, in a qualified annuity, the tax on the earnings is deferred until payout.

A non-qualified annuity is purchased with funds after they have already been subjected to taxation. While the tax on the earnings is deferred, the owner of a non-qualified annuity must pay taxes on profit from the original investment.

Investments in Roth IRAs are quite simple to understand despite what financial ads that run during major sporting events would lead you to believe.

Roth IRAs are for people who have an income of up to $112,000 per year or married couples who earn up to $178,000. What’s great about a Roth IRA is that you do not have to pay taxes on it. No matter how much your investments accumulate, Uncle Sam doesn’t see a nickel of it.

There are several ways you can invest in a Roth IRA. You can set up a Roth IRA as a mutual fund, buy bonds or even invest in real estate. However, as of 2014, you can only invest up to $5,500 per year—$6,500 if you’re over 50 years old. It’s also important to note that you have to earn an income to be able to contribute.

To make investing easier, set up automatic investments to be deducted from your account. This will help you not forget as well as take away any temptation to skip a payment here or there.

How The IRS Handles Roth IRAs

As of 2014, the IRS allows you to contribute up to $5,500 in a tax year if you are under the age of 60—if 60 or older, you can contribute an additional $1000 in order speed up the investments since the window of doing so is closing. In order to contribute the max, those filing individually need to earn a minimum of $5,500 from working and have an adjusted gross income under $114,000 ($181,000 jointly). You can also contribute on behalf of your spouse basically doubling the max contribution and earnings thresholds. You can expect to pay a six percent fee though as it’s seen as a contributions that exceeds the max.

Taking Funds Out

Funds can be taken from the Roth IRA at any point of the duration of the investment. However, this is situational and penalties and taxes may be applicable.

When To Take Funds

The optimal time to take funds from your Roth IRA is when the situation meets the following criteria:

• The account is 5 years old

• You’re older than 59 and a half, or you’re disabled, or the funds are for your first home and this limited to $10,000 through the life of the investment.

• If you were to pass away the funds are available to heirs.

Meeting this criteria allows you to take from the fund without penalty or taxes.

When Not To Take Funds

Taking funds from your Roth IRA before you’ve met the above criteria can lead to having withdrawals taxed at 10 percent. Generally, this means taking it out before you’re old enough—59.5.

However, the following may allow you to make withdrawals without being taxed 10 percent:

• The IRS has levied against the plan

• After losing your job and having to pay for medical expenses

• You take less than what you spend on higher education

• You’re uninsured and need to pay for medical bills

• Buying a home for the first time

• The owner of the Roth IRA has passed away

All withdrawals though are subject to the 10 percent tax For example, you’re buying your first home but the account is not 5 years old.

Requirements Around the Order of Withdrawals

For withdrawals that do not meet the qualifications, the withdrawal is subject to taxation.

• You make regular payments

• Payments that are made via conversions

• Earnings on the investment on payments

Note that rollovers are not considered for this set of requirements.

Roth IRAs for The Deceased

Roth IRAs are distributed amongst heirs and are not taxed as long as the account meets the qualifications. For example, if the account is not 5 years old, the withdrawals is subject to tax—however, the penalty is not incurred. A spouse though can convert the IRA into their own Roth IRA. Doing so allows the IRA to meet the qualifications such as maturing to the 5 year criteria and remains prevents the investment from being taxed.