Chelsey Tucker graduated with a Bachelor of History degree from Metropolitan State University in 2019. She now writes about insurance with her specialty being life insurance and has been quoted on Help Smart Phone and MEL Magazine.

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Dan Walker graduated with a BS in Administrative Management in 2005 and has been working in his family’s insurance agency, FCI Agency, for 15 years. He is licensed as an agent to write property and casualty insurance, including home, auto, umbrella, and dwelling fire insurance. He’s also been featured on sites like Reviews.com.

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Reviewed by Daniel Walker
Licensed Auto Insurance Agent

UPDATED: Mar 19, 2020

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How does an annuity work?

An annuity is intended to save money with a higher interest than a regular savings account, with the option of receiving a monthly income at a certain time. A purchaser may accumulate money and later receive scheduled payments or receive a lump sum.

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The owner of an annuity accumulates their money for a certain number of years, then receives scheduled payments usually after 59 years and 6 months of age. If the owner decides to receive payments as opposed to all of their money at once, they determine a payment based on the life expectancy established by the insurance company.

The insurance company has a life expectancy chart they use to determine that number. They obtain basic medical information from the investor as a guide. The down payment made to an account could be income or funds transferred from an IRA or 401K.

The before tax funds from the IRA and 401K will be taxed at 100% if withdrawn too early however, while the income based deposit is partially taxed. The way annuities are taxed will help you decide if this investment is right for you.

What are the different types of annuities?

The different types of annuities are intended to meet the varying needs of the people who purchase the products. Fixed and variable annuities are both popular options.

  • A fixed annuity is a simple option that receives contributions from the owner and possibly the employer. They receive a small guaranteed rate of return. When the time comes to withdraw, taxes are paid on the last money deposited first.
  • The variable annuity is tied to the stock market usually in the form of mutual funds. The equity-indexed annuity is also tied to the stock market. There are several variations to the variable option. There are also management fees and more expenses associated with this type of account.

Expenses include the surrender penalty that has to be paid if the owner cashes in or transfers their funds before the 5th year. The percentage of fees and penalties can be as much as 20% although they average between 7% and 10%. While the variable is based on an investment portfolio and the market, it is riskier to have a variable account as opposed to a fixed account.

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How do you open an annuity?

The annuity is purchased through an insurance company, a broker, or an investment firm. A lump sum generally exchanges hands with the expectation that the insurance company either:

  • Start making immediate payments to the annuitant
  • Invest the money into a mutual fund pool
  • Agree upon a deferred schedule of payments

You may decide to receive immediate payments. The risk is a major tax burden if this option is taken. You may also decide to invest in the market (through a variable option) with other owners, or you may decide to make contributions, and receive payments at the appointed time. You do not have to take the money at the age of 59 and a half. This time is agreed upon by you and the insurance company.

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May I transfer my 401K to an annuity?

Yes! Many people do. What you have to consider is the annuity taxes and fees you will incur if withdrawals are made before the appropriate time. Taxes are paid on earnings and withdrawals. You may also transfer funds from an IRA under the same terms.

Owners may also transfer annuity funds through the 1035 exchange tax program. This law allows account you to transfer money between accounts tax free. Variable accounts also allow for flexible liquidation or loans against the account.

May I make withdrawals from my annuity?

Sometimes situations come up beyond our control. In these instances it may be necessary to withdraw funds from your annuity. This is definitely possible although there may be fees incurred as a result. The exclusion ratio determines what percentage of the payments are taxed anyway. If there is a need to withdraw funds though, they are taxed at the regular income tax amount.

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What is the payment phase of my annuity?

After the accumulation phase of the annuity, it is time to receive a check. There are several ways in which to receive money:

  • One lump sum
  • Annually
  • Bi-annually
  • Quarterly
  • Monthly

The schedule is established when the contract between you and the insurance company is drawn. If the owner dies before the payments are complete, depending on the payment option, either the balance reverts back to the insurance company or to the annuitant’s beneficiaries. To get free annuity quotes, click on the search tool here!