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Ten Things the Average Person Does Not Know About Annuities
by Robert D. Cavanaugh, CLU
Deferred annuities possess characteristics found nowhere else. They play an
important part in seniors' portfolios. Seniors hold billions of dollars in
deferred annuities. However, my experience is that the average person knows
little about the unique advantages of deferred annuities, much less the options
they have during the holding period.
When you mention the term, "annuity", it typically conjures up thoughts of
getting a small check in the mail every month from some insurance company. It is
viewed as an income. The vast majority, however, of annuities are of the
"deferred annuity" variety.
They are accounts designed to grow money over a period of time in a safe
environment. Over 90 percent of deferred annuities are never "annuitized", that
is, converted to that monthly check in the mail.
So let's take a look at some of the attributes of annuities and, in the process,
clear up many misunderstandings about this vehicle.
Tax Deferred Earnings
Deferred annuities provide "triple compound interest." There is interest on
principal, interest on interest and interest on the taxes you would have paid on
an investment in a non-tax deferred environment.
For example, 6 percent which is taxable is equivalent to an 8 percent non-taxed
return assuming a combined federal and state tax bracket of 25 percent.
Safety
While deferred annuities are not FDIC insured, like a CD with a bank, they are
backed by the generally billions of dollars of the insurance company's assets.
No big risks here.
A Competitive Interest Rate
Insurance companies normally set the interest rate for a deferred annuity
contract annually. You will find that it is usually one to two points above CD
rates. So not only do you get a higher rate but the interest is tax-deferred,
unlike a CD where you pay taxes on the interest each year.
Some deferred annuities offer a rate that is guaranteed for a number of years,
such as five. If you think interest rates will fall, you can lock in today's rate.
Minimum Interest Guarantee
When you get to the end of your annuity time frame, if your annuity has not
given you at least a minimum of (generally) 3% interest per year, then the
insurance company will apply their minimum guaranteed rate. Nothing to get
excited about, but at least you know that you can't lose money and there is a
minimum interest rate that is guaranteed no matter what.
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