A Close Look at Tax Sheltered Annuities

** This excellent guest post by David Brown illuminates Tax Sheltered Annuities.  Enjoy!

A Tax Sheltered Annuity (TSA) is a kind of annuity which permits an employee to contribute from his income to a retirement plan. The contributions are not taxed until the person decides to withdraw his money from the plan. Moreover, the employer can also contribute to this plan which makes it all the more attractive. Public sector employees and self employed people are the ones who mostly benefit from TSA.

403(b) Tax Sheltered Annuity- The most popular TSA

IRS code 403(b) says that employees of educational institutions, non-profit institutions and self employed ministers can make contributions from their employment earnings to supplemental retirement accounts called tax sheltered annuities. These accounts are tax-advantaged. The Money is taxed only after withdrawal. The employer can contribute to this account but it is not obligatory for him to do so. To enroll, you just need to fill and sign a salary reduction agreement which has the details of the amount of money that will be deducted from your salary for a specific period of time.  Initially people were only allowed to invest in annuities but now they can invest in mutual funds as well.

In addition to 403(b) there are other kinds of TSA like 457(b) and 403(a). While 457(b) is about employees of city and state governments, 403(a) addresses self employed people. It is worth mentioning that all the TSA are fundamentally similar.

What are the advantages of TSA?

1. TSA can very well supplement social security benefits. The salary reduction arrangement also makes life easy for people.

2. Tax deferred savings growth makes TSA a very attractive proposition. The money that would have been lost in yearly taxation is now invested and is supposed to generate income.

3. A great thing about TSA is that you can save while reducing taxable income. Since your total taxable income is reduced you may also fall into a lower tax bracket. This means that you will have to pay less money to Uncle Sam in terms of tax.

4. Here the growth of funds is tax-deferred which will ultimately make you quite a bit      richer in the long run.

5. Generally speaking, TSA plans offer flexible terms and conditions.

6. You will have full rights over the funds even if you are no longer associated with your contributing employer.

7. Although the maximum annual contribution that can be made to TSA is $11000 but people who are above 50 years of age can make additional contributions upto $5500.

8. Participating in TSA does not reduce the benefits of your other retirement options like pensions or social security.

It should be noted that a 10% penalty will be charged by the IRS in case of premature withdrawal of the funds.

Tax Sheltered Annuities are supposed to act as supplemental retirement programs. Remember that under normal circumstances they are not an alternative to traditional retirement options. However, they can be beneficial to people, especially to people who do not enjoy the post-retirement privileges offered by private sector companies to their employees. TSA cannot provide you shelter from any financial crisis like debt but they can complement your retirement plans and make your future more secure.

Equity Indexed Annuities vs. Alternate Investments

How do equity indexed annuities stack up against other investment options?

This question and answer editorial in the Dallas Morning News points out the need for analytical inspection of investments in the proper context.

One main point left out is the additional benefit of tax deferral that is inherent in all annuity contracts.  If alternate investments are held outside of tax deferred retirements accounts, annuities will provide a significant account value advantage.

Always do your homework and choose an advisor who won’t overlook any of the benefits or disadvantages.

Pros and Cons of Variable Annuities

Variable Annuities:  Pros and Cons

No other product in the Annuity business creates as much controversy as Variable Annuities.  Frankly, I’m getting kind of tired of all the loud opinions about variable annuities- it’s either a table thumping BUY or a screaming SELL.  It’s  just like watching Jim Cramer on Mad Money.   There’s no middle ground, and if you follow the BUY side (selling agents) every sales office should have a line of people waiting to buy.  Listen to the SELL crowd (journalists and many financial planners) every insurance company would be shut down because of fraud.

I know that sounds extreme but it really does show you the difference in the type of advice you are bound to get.  So if you are familiar with my work, you’ll know that I try to be objective and provide solid evidence as to the pros and cons of annuities of All shapes and sizes.

Frankly, I’ve avoided writing this for a long time, because these are complicated beasts and it’s hard to make any kind of apples to apples comparisons.  But I’ll tackle the variable annuity debate in this article.  Before I go further, let me say that even after my  research and experience in the industry, I am not overwhelmingly for or against variable annuities.  Like a lot of things in life, there are times when they work great and others when they are completely inappropriate.

Pros of Variable Annuities

Guaranteed Benefits:

• Death Benefit- This allows the heirs of the contract to inherit the full principal balance in the event that the contract owner passes away while the contract is in force and the account has lost value

• Income- This allows the contract owner to lock in a predetermined level of future income regardless of account performance.

• Principal- This allows the contract owner to recover the principal investment or the highest contract value achieved regardless of the account value at time of surrender.

Tax Deferral:  Taxes are deferred on the growth of assets inside an annuity giving the contract owner the added benefit of greater compounding.  Many critics suggest that excessive fees mitigate tax deferral benefits.  If tax deferral is the sole focus of purchasing an annuity, expensive optional riders can be waived so that total fees will run no higher than the average mutual fund.

Unlimited Contributions: Retirement plans have contribution limits.  If you ever come in to a larger sum of money, much of it will not be eligible for allocation in a 401K, IRA, etc.  Annuities have no contribution limits.

Cons of Variable Annuities

• High Fees:  Many annuities have optional riders that push the overall fees to 3% or more.  Plenty of products allow an investor to elect out of the options but some don’t.  If you are purchasing an annuity with high fees, there had better be compelling reasons to do so.

• Limited Investment Choices: Asset allocation options are limited within an annuity.  Some contracts have predetermined portfolio balances and others will list a limited number of available mutual funds.

• Surrender Charges: As with all annuities, variable products have surrender charges so your money is tied up for a specified period of time except for the usual 10% annual free withdrawal. Be positive that the surrender schedule works with your investment time horizon.

• Immobility: The combination of investment limitations and surrender charges means that your money is much less mobile than it would be in an equivalent securities account.

As you can see, the analysis is pretty simple.  If you are looking at the prospect of a variable annuity just weigh the pros vs. cons to figure out if it works for you.

For most of my customers and following our decision tools to Buy Annuities, most of the cons seem to be deal breakers if even if a few components are tolerable.  Overall, for me, the cons outweigh the pros most of the time.  Variable annuities have specific uses for a small class of investors that either works for you or it doesn’t.  Make sure to seek solid advice from an open-minded advisor.

Pros and Cons of Equity Index Annuities

Equity Indexed Annuities are without a doubt the most complicated type of annuity  I can’t stress enough the importance of an expert advisor when these are being considered.  The biggest problem is that equity indexed annuities are a favorite product of greedy salesmen because some companies pay excessively high commissions.  The case study on annuity sales tactics will alert you to the dangers you may face as a potential annuity buyer.

Are you ready for an explanation yet?  Please forgive me.  I am often disgusted by the dirty tricks some of my “colleagues” use.

Equity index annuities offer principle guarantees with potential growth tied to a major stock market index.  You’ll get your money back in the worst-case scenario and you may profit nicely if things go well.

In order for these contracts to work there are several components that work for or against you.  So let’s get started…

Benefits

Principle and Growth Guarantee- Your initial investment is secure and guaranteed to grow at a low rate.  The contract will state the minimum amount you can expect to receive at the end of the surrender period.

Tax Deferral- Like all annuities, your money grows on a tax-deferred basis.

Account Step Ups- In most cases, a new base contract value can be locked in when the index performs well.  This gives you the benefit of locking in a new guaranteed basis when the market works the way we all want it to.

Disadvantages

Capitalization Rates- All contracts state the maximum amount of interest that will be credited to the account.  This can be calculated in a variety of ways such as on a monthly or annual basis.  With an annual cap rate of 9%, the market index may return 20% but the account will only be credited with the maximum cap of 9%.

Participation Rates- All contract also stipulate the percentage of the index gain that will be credited to the account.  This will range from 60%-100%.  If the index gains 10% and the contract has a 60% participation rate, the account will be credited with 6% interest.  This is also subject to the Cap Rate where applicable.

Long Surrender Periods- These contracts often have very long surrender periods.  One reason for this is the fact that you have a better chance for favorable index performance over a longer period of time.  Even so, if you have a time horizon of more than 10 years, the principle guarantee may not be as important.  Let me state for the record that I have yet to see a good equity indexed annuity with a long surrender period.  For instance, one of my favorite products in this category has a five-year surrender period.  If you happen to really like it after five years, then buy it again and make it a ten-year strategy.  If it doesn’t work that well then you’re money is free a lot sooner.

Crediting Methods- This determines how the index return is credited to your account balance and can have a dramatic effect on the performance of the annuity.  Two common methods used are monthly averaging and point-to-point.  The averaging method will credit the monthly index average to the accont.  The point-to-point method will compare the starting and ending values of the index, on a monthly or annual basis, to determine the total return to the annuity account.  Also, for additional fees, a highwater mark feature can be added to point-to-point option so you can look back over the period and take the highest value for crediting purposes.  All crediting method options are subject to participation and cap rates.

This is a very basic approach to the complexities of equity-indexed annuities.  Visit the Straight Talk section of the website for a more critical look at this product type.  In reality, the real analysis begins when you are presented with an individual contract.  That’s why The Annuity Report is essential reading and is available for download with a free membership to the site.  With the report you’ll be learn all you need to steer around the aggressive sales tactics and find a qualified advisor.

Pros and Cons of Fixed Annuities

Fixed Annuities are the easiest of all annuity products to understand. You invest money with the insurance company and they pay you interest. When the investment term has expired, you can elect to have your account balance paid out as a stream of income or you can take the entire lump sum and go elsewhere. That’s as simple as I can put it. Of course it does get more complicated but that’s why I did so much work to give members of this site all the tools they’ll need to make a good decision.

The benefits of fixed annuities are quite clear…

Guaranteed Interest- You can lock your interest rate for the life of the contract with a CD-type annuity or choose a floating rate that moves up or down according to normal interest rate fluctuations. Either way, your interest is guaranteed to not go below a certain level as specified by the contract.

Tax Deferral- Accumulation within the contract happens on a tax-deferred basis so you have the benefit of additional compounding that gives an effective yield that outpaces other safe cash investments.

Free Withdrawals- Every contract comes with a provision that allows you to take anywhere from 10-15% of the account balance annually without penalty. This can be used to meet minimum distribution requirements in retirement accounts or for discretionary expenses. The money is yours so do whatever you want.

Ultimate Safety- Insurance companies are much more conservatively capitalized than banks so the guarantees mean more, in my opinion. The insurance industry has a much lower default rate than the banking industry and all states have an insurance guaranty fund that matches, and in some states, exceeds insurance provided to banks via the FDIC.

The disadvantages of fixed annuities are equally as clear…

Surrender Periods- Fixed annuity contracts require you to keep your money invested for a specified period of time. In exchange for your commitment to keep your money with the company, there is no up-front sales charge for your purchase. The investment term is known as the surrender period and there is a back-end charge if you fail to fulfill your end of the deal. The surrender period must work within your time horizon. If you need more money than is available via free withdrawal before the end of the contract, this product is not for you.

Conservative Growth- Fixed annuities will never make you rich. They are meant for asset preservation and safe appreciation. These products work just before or during retirement because of safety; don’t expect rapid growth. If you’re a golfer then you know to use a driver on the fairway and a putter on the green. Consider this the best putter money can buy, but keep it in your bag until the time is right.

For now, that’s all I can say about fixed annuities. Proper placement in a retirement requires expert advice and analysis. In addition, there are thousands of available products and even more greedy agents selling them. That’s why you need The Annuity Report so you can understand the specifics of fixed annuities in detail. This valuable creation of mine is available for download with a free membership to this website. From this report, you’ll learn how to tell the difference between a good product, company or agent and a bad one.

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