Ordinary Annuity Guide
An ordinary annuity is considered by most people to be a fixed annuity. A fixed annuity is one that pays a fixed amount of earnings regardless of the performance of stock or bond markets. The fixed amount varies depending on the insurance company that issues the annuity, but is usually between 3% and 5%.
An ordinary immediate fixed annuity is a relatively safe way to generate guaranteed income for life. It is purchased with a single, lump-sum premium. Payouts by the insurance company begin immediately. If an ordinary annuity is purchased with after-tax dollars, taxes are paid only on the portion of the payment that represents earnings.
Ordinary Annuity Basics
When the contract for an ordinary fixed annuity is signed, the premium given to the insurance company is invested in extremely conservative, low-risk mutual funds. These funds will typically invest in high-quality government and corporate bonds. High-quality bonds are considered to be much safer investments than equities because bondholders are required to be paid first should the company that issued the bonds declare bankruptcy. Owners of common stock, however, risk their entire investment, as they are not required to be paid if the company is liquidated.
Fixed annuities are most often recommended as immediate annuities for those in retirement. However, a fixed annuity can be useful for an investor who has not yet retired. If his or her other investments incur substantial risk or if there are no other significant assets, a fixed annuity can provide stability without a risk of loss.
Comparing an Ordinary Annuity to Variable and Indexed Annuities
While ordinary fixed annuities are relatively safe because they invest in high-quality bond funds, there are two other types of annuities in which an investor can take on more risk in an effort to gain more growth: Variable annuities and Indexed annuities. Depending on where an investor is in his or her investing timeframe, he or she may want to consider one or both of these types of annuities.
A variable annuity is best suited for an investor with 10 or more years before he or she will need to begin receiving payouts from the annuity. Variable annuities achieve their growth by earnings derived from the stock market. When the annuity contract is signed, the insurance company invests the premium per the owner’s instructions. If he or she is looking for maximum growth, the choice of funds will include a number of highly aggressive stock funds. These can be domestic funds, foreign funds, emerging markets funds or any number of other types of funds.
It might be easier for the variable annuity newcomer to think of a variable annuity as a “fund of funds”. It’s also important to remember that with growth comes risk. The higher the return that the investor is attempting to gain, the more risk he or she must take.
An indexed annuity is sometimes considered to be a hybrid between a fixed annuity and a variable annuity. Like a variable annuity, it can grow through an investment in the stock market. But, like a fixed annuity, it can offer relative safety.
The gains paid on an indexed annuity are tied to an underlying stock market index. The Standard and Poor’s 500 is the index most often used, as it viewed as the most representative of American industry. However, indexed annuity funds cap the rate that will be paid. For example, if the cap rate is 6%, even if the S&P 500 rises 8%, only 6% will be paid to the annuity. In order to offer an additional level of investor protection, most insurance companies now also offer a floor at which losses will not drop below. If the floor is 0%, and the market is down 3% for the year, the investor will lose nothing.
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The Key Benefits of an Ordinary Fixed Annuity
An immediate ordinary fixed annuity offers three very important financial protections: Guaranteed income for life, asset protection from creditors and no limit on the amount that can be contributed.
Guaranteed Lifetime Income
While life insurance is sometimes referred to as protection against dying too soon, ordinary annuities are sometimes referred to as protection against living too long. Outliving ones financial resources is becoming more of a concern as people are living longer in retirement. An investor who reaches retirement age at 65 may need income for 20, 25 or 30 years. And, getting older often does not get cheaper. Expenses during retirement can be just as high as they were before retirement.
An ordinary annuity can provide a much-needed financial cushion. Further, investors can add options to an ordinary annuity such as one that pays a death benefit to a beneficiary or one that continues to pay a surviving spouse until his or her death. And, the tax treatment of an ordinary annuity is very favorable. All earnings grow tax-deferred until they are taken as part of a monthly payout.
Protecting Assets from Creditors
Annuities represent irrevocable contracts. As such, the premium that is given to an insurance company in exchange for monthly payouts is protected from creditors and most legal judgments. In addition, several states also protect the annuity payouts as they are returned to the annuitant. This can be especially beneficial for those professionals who can be sued frequently, such as lawyers, surgeons and contractors.
No Limit to Contributions
There is no limit to the dollar amount of a fixed annuity, and no limit to the number of annuities an investor can have. For investors looking to guarantee a large income in retirement or for those who have contributed the maximum to retirement plans, ordinary annuities can provide a substantial advantage over other types of annuities and other types of retirement savings vehicles.
One final advantage to an ordinary fixed annuity is that the payouts are allowed to pay long-term care insurance premiums while still allowing the owner to qualify for Medicaid. This is optimal for an investor who would otherwise have to sell all of his or her assets in order to qualify for nursing home care paid for by Medicaid.
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