When you are getting close to retirement, there're a lot of decisions to make, such as where to live and what to do for starters. There are also a lot of financial decisions. One of them is how to create income and replace the paycheck. Should you take an annuity option from your retirement plan, or an annuity that you own? The beginning is a good place to start. What are annuities worth?
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Pay Me Now or Pay Me Later?
There are two basic types of annuities:
Deferred annuities: These have two phases, accumulation and payout. You buy a deferred annuity policy by making a single payment or a series of payments. During the accumulation phase, payments grow in the annuity. During the payout phase, the accumulated money is used to create a lifetime income.
Immediate annuities: These are also known as income annuities. That's because the insurance company begins to pay an income immediately after receiving a purchase payment, or premium.
Immediate annuities income options:
Life-only: A payment is guaranteed for the lifetime of the annuitant. No payments are made after the annuitant's death. Life-only options will pay out a higher monthly or annual income than the other options. Joint and survivor life-only is available for the longer of two lives, usually spouses.
Life and period certain: A payment is guaranteed for the lifetime of the annuitant. The payments are made for at least a "certain" number of years regardless of when the annuitant dies. The certain year options are usually 10 and 20. Joint and survivor options are available for life and period certain.
Fixed Period: Payments are made for a specified number of years regardless of when the annuitant dies.
Insurance companies calculate the payout for life-only and life and period certain using an annuity rate. Fixed period payouts are based strictly on interest rates.
What Annuities Have Cash Values?
Fixed deferred annuities have cash values. During the accumulation phase the value grows tax deferred. That means no tax on interest or gains is paid until money is withdrawn. The cash value accrual of a fixed deferred annuity is the accumulation of payments and interest.
The values of a fixed deferred annuity are guaranteed by the insurance company. The guarantees apply to:
- The cash value: Payments accumulated at the interest rates applied
- The cash surrender value: The cash value minus any charges for cashing in the policy
- The annuity payout factors: The rate applied to calculate annuity income
- Minimum interest rate: The rate applied to the cash value
Fixed deferred annuities offer competitive low risk returns. Fixed annuity interest rates are usually higher than CDs or other low-risk investments.
Variable annuities have account values which are not guaranteed. The account values rise and fall based on the underlying investments.
Surrender Charges and Market Value Adjustments
Most fixed deferred annuities have a schedule of surrender charges for anywhere from 3 to 10 years. If you cash in the policy during the surrender period, the insurance company deducts a percentage of the cash value. During the surrender period there may also be a market value adjustment.
A market value adjustment can be either a charge or a credit based on current interest rates when you surrender the policy. If interest rates are higher when the policy is surrendered than they were when it was purchased, the insurance company will charge you. If, however, interest rates are lower, than the insurance company pays you a bonus.
Immediate Annuity Cash Values
When you purchase an immediate or income annuity, the payment is made to the insurance company in exchange for lifetime income. There is no cash value. However, there is value in the stream. There are companies called factoring companies who will buy your immediate annuity from you. Here's how it works.
The factoring company calculates the total payments that they expect to receive in the future based on your age, gender, and the income option that you selected. Then the factoring company determines the present value, or what those payments are worth today, the same way the insurance company does when you buy the annuity. Then the factoring company "discounts" the value, which is a polite way of saying they offer you less money than the income is worth to you. Often, substantially less money.
Some insurance companies will buy back your annuity if you no longer want to receive payments.
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Congratulations! You Won the Lottery! Now What?
Many lottery games offer a choice of a cash value or an annuity. The prize value for games like powerball and mega millions is actually the total payments made over 30 years to the winner. The cash value is the value of the payments made over 30 years in today's dollars. How does it work? It's the amount of money needed today, accumulating at a rate of interest to make the payments over 30 years with nothing left at the end. The most important part of the calculation is the interest rate. The higher the interest rate the less money needed to make payments. What does that mean? If you win the lottery, talk to a professional advisor before you decide which option to take.
Why Use an Independent Insurance Agent?
Independent insurance agents are annuity professionals. The have the knowledge and experience to help you make a smart choice. And independent agents work for you, not the insurance company. Find an independent insurance agent in your community here.
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