Understanding Annuities

Wouldn't it be nice to live the lifestyle you want throughout retirement? Of course, you'll need money to maintain your standard of living. Some people make sure they'll have a source of income by purchasing an annuity from an insurance company either before or when they begin retirement.

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An annuity is different from most other retirement savings vehicles — it's a contract between an individual and an insurance company. In return for making one or more premium payments, the insurance company agrees to pay the individual back, plus interest, in the future. The payment is made in either one lump sum or a series of disbursements.

The main benefit of annuities is tax-deferral . With an annuity, your principal and earnings compound on a tax-deferred basis.

What are my options?

There are two types of annuities — fixed and variable . The biggest difference between the two is how potential earnings are achieved. Fixed annuities earn a fixed interest rate that is guaranteed by the issuing insurance company for a specific period of time. The return on a variable annuity is linked to the performance of the underlying investment sub-accounts — usually a combination of stocks, bonds, and/or money market securities — in which the contract owner chooses to invest. With variable annuities, as with any investment, the value of sub-accounts will fluctuate with market conditions.

In addition to being fixed or variable, annuities are either qualified or non-qualified. Qualified annuities are purchased to fund a qualified retirement plan, such as an IRA, 401(k), or SEP. They may also be used for rollovers and transfers from other retirement accounts. Contributions to a qualified annuity may be tax-deductible. Non-qualified annuities are purchased with after-tax dollars. Contributions to a non-qualified annuity are not tax-deductible.

Features and benefits

Tax-deferred growth.

You don't have to pay taxes on the earnings in your annuity account until you begin taking distributions. As long as you leave what you earn in your plan, interest is paid on increasingly larger balances.

Unlimited contributions.

There's no limit to the amount of money you can put into a non-qualified annuity. This is particularly attractive to those who have delayed saving for retirement and those who are not covered by an employer-sponsored retirement plan.

Flexible income options.

You can choose from a number of payout methods, such as receiving the value of your annuity all at once, or taking distributions over time. You can even receive guaranteed income for life. Access to funds during emergencies. Most annuities let you access a portion of your funds without contract penalties to meet emergencies or other income needs.

Your money may be available when you need it most, for needs like extended care or terminal illness. In addition, some annuities offer other early disbursement methods for which surrender charges do not apply.

No probate.

When you die, your annuity will usually pass to its named beneficiary(s) free from the cost, delays, and publicity of probate. This allows you to protect money that you have earmarked for beneficiaries.

To keep in mind

Annuities generally have surrender charges in the first 5 to 8 years of the contract. Surrender penalties are levied on distributions that are taken in excess of the annual surrender-free distribution provisions set out in the fixed annuity contract or variable annuity prospectus. Some annuities allow you to take 100% of accumulated interest earnings from your policy without a surrender charge. Review the contract for details.

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In addition, any distributions taken prior to age 59½ are generally subject to a 10% federal income tax penalty.

Who chooses fixed annuities?

People who are at or are beginning to prepare for retirement, and who want the security of knowing exactly how much their money is earning, typically purchase fixed annuities.

Fixed annuities also have the benefits of:

  • Guaranteed principal. Your principal is guaranteed by the issuing insurance company.
  • Guaranteed minimum rate. The issuing insurance company will guarantee that you will never earn less than their fixed rate of return (typically 3% to 4%). 2, 3

Who chooses variable annuities?

A variable annuity may be right for you if you can withstand market fluctuations.

They have the added benefits of:

  • Flexible investment options. You invest as conservatively or as aggressively as you want in a variety of sub-accounts — that may contain stocks, bonds, and money market securities — creating a portfolio that suits your personal goals, time horizon, and tolerance for risk.
  • No tax on transfers between portfolios. As opposed to a mutual fund, a transfer between investment sub-accounts within your annuity is not a taxable event. You can change your investments as your needs and risk tolerance changes, without worrying about tax consequences.
  • Protection for your beneficiaries. In the event of your death, the value of your contributions (minus any withdrawals) is protected for your beneficiaries through the death benefit feature. (Your beneficiaries will, however, be subject to taxation upon inheriting any annuity-held assets.)

If you have more questions about variable annuities, contact a Wells Fargo Investments financial consultant.

Variable annuities are flexible long-term retirement investments. They are also relatively complex investments, and it's important that you gain an accurate understanding of how they work, including reviewing all fees, expenses, sales charges, and risks, associated with variable annuities, before making a financial commitment. Most annuities are sold by prospectus, which contain complete product details, and investors should read a variable annuity's prospectus carefully before purchasing a contract.

Additionally, Product, Portfolio and Rider offerings may vary by state. There are additional fees and expenses that will apply. Investors in lower tax brackets need to consider whether the benefits of tax deferral will offset these costs. Please consult your tax advisor before purchasing a variable annuity contract or making any other tax-advantaged investment.

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