The world of insurance and financial product sales is a large confusing one. First, you have the myriad of different products that already exist. Annuities, Whole Life Insurance, Indexed Annuities, Long-Term Care, Variable Life Insurance, Individual Health Insurance, Accidental Death & Dismemberment, etcetera, etcetera. Each comes with their own text book of explanations, definitions and specific rules. Then you have the tax implications of buying and using these products for yourself. Finally, you know you pay something to the broker that sold them to you, but you’re not entirely sure how much that “something” is.
There are a lot of financial products to be discussed, but since the baby boomers are the largest generation and are nearing retirement, and fixed annuities are often products aimed at retirees, I thought I’d give a quick overview of what they are and how they work. This is not comprehensive; but if you’ve been approached about buying a fixed annuity, or if you’re considering it, please take a minute to read the following. It might just save you a big realization of regret later on.
Fixed Annuities come in a number of different shapes and sizes. There are single premium, installment, joint life, period certain, and a whole host of other types. There are also a bunch of riders and add-ons that you can get too. Just about every major financial or insurance company in the country has its own suite of fixed annuities.
Despite these details, all fixed annuities essentially work the same way. There are four basic components to think of in a fixed annuity: how they are funded, how they work, how they are taxed and how they are cancelled.
How They are Funded
Fixed annuities are normally funded in one large lump-sum payment, but can also be funded in installments over a relatively short period of time. This payment could be old 401k money, a large chunk from your savings account, the balance in your Roth IRA or even the cash value from an old whole life insurance policy via a Section 1035 exchange. There are really no limits on the type or kind of assets that can be used to purchase an annuity, and the broker usually doesn’t care what those assets were previously used for or how they are taxed. They are paid a commission on the sale of the product.
How They Function
The term “annuity” is derived from the idea of annuitization, which