Liquidity and Annuity TypesWhile all annuities have some features in common, there are actually many different types. Likewise, they can have different “rules,” such as when you may access funds – or even IF you are allowed to do so. For example, annuities can be either immediate or deferred. With an immediate annuity, income begins soon after you’ve made your contribution (typically within 12 months of purchase). Many people purchase single premium immediate annuities, or SPIAs, so that they can create an ongoing stream of income in retirement. With a SPIA, once the income stream has begun, it is an irreversible decision, and because of that, you will not be able to withdraw your contribution in a lump sum. Therefore, the money that you use to fund an immediate annuity should be funds that you won’t need for future emergencies or other financial obligations. Deferred annuities work a bit differently. With these financial vehicles, you can make one or more contributions over time, and the income can then begin in the future. A deferred annuity will typically allow you to have some amount of liquidity during the accumulation period (i.e., the time period before you convert the annuity to an income stream). In this case, you can usually access up to 10% of the contract’s value after the first year. Any amount over and above that, however, could incur a surrender penalty. The surrender charge period may last for several years. However, the amount of the surrender penalty will usually decrease over time, until it eventually disappears. Should you opt to convert a deferred annuity into an income stream, similar to with an immediate annuity, the decision cannot be reversed. Therefore, while you can receive regular income payments, you won’t be allowed to access large withdrawals.
Taxes and Annuity WithdrawalsThe amount of tax that you owe on annuity income and withdrawals can depend on the type of annuity you have. For example, there are qualified and non-qualified annuities. Qualified annuities are typically funded with money from retirement plans, such as IRAs (Individual Retirement Accounts) and/or employer-sponsored accounts like 401(k)s. Because these funds usually go into the account pre-tax, and the growth is tax-deferred, none of it has yet been subject to taxation. Therefore, 100% of withdrawals and income from qualified annuities are taxable. Alternatively, a non-qualified annuity is one that is purchased with after-tax dollars. So, for instance, you could purchase a non-qualified annuity with money from your personal savings account. The funds inside of a non-qualified annuity still grow tax-deferred, though. This means that some of the money in a non-qualified annuity has been subject to taxation (i.e., the original principal) and some of it has not (i.e., the growth). In this case, then, a portion of your income or withdrawals – that which represents the growth – will be taxed, and a portion will not be. It is important to have a good understanding of the possible tax consequences when accessing money from an annuity, because it can have a big impact on how much net spendable funds you will have available. This is particularly important now because the U.S. has been languishing in a low tax rate environment for many years – but this will not last forever. Given that, if (or when) tax rates go up, your net spendable cash can be reduced.
Top Federal Income Tax Rates 1913 – 2022
Source: Inside Gov (http://federal-tax-rates.insidegov.com/)
Items to Consider Before You Access Money from an Income AnnuityWhile annuities can certainly provide you with peace of mind, knowing that income will arrive on a regular basis, there are some items to consider before you purchase one, such as:
- Whether you may need the contribution for other obligations
- Your time frame until retirement
- Other sources of retirement income
- How much income you will receive from the annuity
- The length and amount of the annuity’s surrender period (if applicable)
- How much spendable income you will have after taxes