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Definitions of Terms


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Planning for Retirement and More With Annuities

What is an annuity What is an annuity?
Employer Sponsored Retirement Plans
    401Ks SEPs Keogh Plans What are 401(k)s, IRAs, SEPs, etc.?
Individual Retirement Plans Individual Retirement Plans
    Difference between annuity and IRASo what's the difference between an annuity and an IRA?
Benefits of owning an annuityBenefits of Owning an Annuity

We've all heard the terms 401(k), 403(b), SEP, SIMPLE, Keogh Plan (HR-10), and pension plans. All of these are plans for saving for the retirement of the individual. The plans themselves may be funded by annuities, mutual funds, bank CDs, etc.

Annuities are also used to fund College Plans, LTC plans, and more...

What is an annuity?

You might think of an annuity as a savings account at a bank. With a savings account, you deposit money in the account and the bank promises to pay you interest on the balance (minus the monthly fee). Of course, there are restrictions on savings accounts, usually a minimum required balance and/or a limit on the number of withdrawals allowed during a period of time. If these restrictions are not met you must pay a penalty.

An annuity functions in the same way except that it is designed for more long term savings, years verses months. Also, your deposit is not with a bank but with an insurance company which in turn invests your money and pays you interest.

As with the bank account there are fees and restrictions. Some annuities require fixed and regular deposits. There are limits on the number and amount of withdrawals, and penalties apply if these restrictions are not met. Although most annuities are purchased to fund retirement they can be purchased for any purpose that requires an income-stream such as in structured settlements or Education IRAs. By definition therefore an annuity REQUIRES that systematic withdrawals are taken once the annuity matures; for retirement annuities this would be when the annuitant reaches retirement age.

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Employer Sponsored Retirement Plans

What are 401(k)s, SEPs, Keogh plans, etc.?

All of the terms above represent retirement plans, defined, or 'qualified', by the federal government and whose concepts can be traced back to the Employee Retirement Income Security Act (ERISA) of 1974. ERISA was created to protect the rights of workers under an employer-sponsored retirement plan. Prior to 1974 a common plight of workers was to work many years for an employer, only to be terminated shortly before retirement, thereby putting an end to any pension benefit. To encourage companies to estabish retirement plans for their employees, ERISA defined sets of criteria, or plans, that if followed would provide favorable tax treatment to the companies, and would protect the contributions of the employee by requiring that the funds be held and invested by a third party.

Employer plans include: profit-sharing plans, stock bonus plans, money purchase plans, Tax Sheltered Annuities or 403(b)s, 401(k)s, and IRC Section 457 Deferred Compensation Plans. Qualified plans for the small employer include: Keogh Plan (HR-10), SEP, and SIMPLE.

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Individual Retirement Plans

For those of us unfortunate enough to not have an employer-sponsored plan, or for those who would like to supplement their plan, an annuity is just what you need.

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So what's the difference between an annuity and an IRA?

An IRA can be either an account or an annuity. An Individual Retirement Account is an IRS approved trustee or custodial account (set up by a bank, federally insured credit union, savings and loan association, or other approved entity). An Individual Retirement Annuity is an annuity, purchased from an insurance company, that meets the guidelines of the federal governement to receive certain tax benefits. An annuity is a contract under which a series of payments are promised to a person in exchange for a single payment or series of payments. When an individual applies for an annuity they must specify on the application form whether or not the annuity will be used for a "qualified plan" or an "unqualified plan" that is, whether or not it will qualify for tax favored treatment. If the annuity is set up as a qualified plan, the insurance company will manage the annuity per the regulations and restrictions set forth by the IRS. The company will also include this information in its reports to the IRS and any taxation of contributions or withdrawals will be based on this information.

For more information on IRAs, see "Rebuilding Your Nest Egg - Part 4" on our GetFinancialAdvice Blog.

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Benefits of Owning an Annuity

Guaranteed Return of Deposit plus Interest - Unlike most investments today fixed annuities* guarantee a return of your deposit plus a minimum annual interest rate at the end of a specified number of years. The guaranteed annual minimum interest on most fixed annuities is 2 to 3%. Few investments today offer this guarantee. In addition, if it is part of a qualified plan you can enjoy considerable investment growth through triple compounding.

*Fixed annuities offer a guarantee of principle, however index annuities and variable annuities are subject to loses from the market.

Your Deposit is Safe - Annuities are sold by insurance companies. These companies are legally required to hold a reserve to secure your deposit. The companies are also regularly scrutinized by you local state insurance department to ensure that they are solvent and able to meet their contractual obligations. In addition, GETFINANCIALADVICE.COM only recommends insurance carriers that are rated excellent or better by AM Best and company.

Family Protection - Annuities can provide a guaranteed income stream for a specific number of years or for life. However, if you should die before initiating that income stream, your annuity account value may be paid directly to your designated beneficiary. If immediate access to the accumulated value is not required; the account value can be left to accumulate income tax free.

Accessing Cash from Your Annuity - Most annuities allow you to access a percentage of your account value annually without penalties from the insurance company or if you are disabled or confined to a nursing home. However, all withdrawals prior to age 59 ½ may result in a 10% penalty tax by the IRS.

Avoid Probate - With an annuity, all death proceeds pass outside of probate if the proceeds are payable to a beneficiary other than the estate. Thus, the response, delay, frustration and publicity of the probate process is avoided.

Provide for Retirement - Of course, we can't forget the very reason why most annuities are set up - to provide for retirement.

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