Another thought provoking article by Ernie McDaniel
You're right, “annuity” may have different meanings to different people and in different contexts. Sometimes it is shorthand for “immediate annuity” and sometimes for “deferred annuity”. Big difference!
An immediate annuity is an arrangement where someone agrees to pay someone else on a regular basis, monthly for example, a certain amount of money for an extended period of time. This extended period may be specified, for example, ten years, or it may be for the lifetime of the payee, an unknown period of time but nevertheless actuarially predictable. The period may even be for as long as either of two payees is living, which is also actuarially predictable.
The most obvious example of an immediate annuity would be the typical pension plan that some companies (fewer and fewer these days) pay retired employees. Pension payments can vary greatly in their structure. For example, they may pay a designated amount as long as the retiree is alive, or a reduced amount for as long as either he or his spouse live. Furthermore, payments may or may not be integrated with Social Security benefits, and they may or may not have cost of living adjustments.
Some companies allow an employee to take a lump sum distribution rather than requiring an immediate annuity payment method. When you have the choice, which is better? The answer depends on your goals. My experience has been that most people like the personal control that a lump sum distribution allows them. They can choose where to place the money and when (and whether) to take income. They may also hope to pass this asset on to their children, or at least some remaining part of it, rather than to have it be of zero value at their death as would be the case with an immediate annuity from an employer retirement plan. Of course, there is the possibility that a retiree might be irresponsible with his lump sum retirement wealth and soon dissipate it. With freedom comes responsibility.
Important: If a lump sum arrangement is chosen, the distribution would likely be rolled into an IRA; otherwise, the income tax consequences could be devastating. Imagine income taxes (and penalties, if the retiree is under age 59 1/2) on hundreds of thousands of dollars!
Now, let's talk about the deferred annuity. It differs from the immediate annuity in that it is primarily an accumulation vehicle while the immediate annuity is primarily a distribution vehicle. (A deferred annuity can eventually be converted into an immediate annuity but that is not usually required and it may or may not be an advantage.)
There are several different types of deferred annuities and space here does not allow a discussion of them. Suffice it to say, though, that they offer the following potential advantages for non-IRA money in the state of Louisiana: 1) tax-deferral; 2) probate avoidance; 3) protection from lawsuits. IRA's already have these potential advantages in Louisiana, so deferred annuities do not add to these. Some deferred annuity products may have opportunities beyond these that make them worth considering even for IRA money.
As with IRAs, deferred annuity distributions before age 59 1/2 may be subject to tax penalties on previously untaxed money. However, they differ from IRA's in that distributions are not required beginning at age 70 1/2. Generally speaking, there is no maximum contribution to a deferred annuity, unlike with an IRA, and some investors therefore delight in the general availability of this tax-deferral opportunity.
So, now you know. The next time you hear the word “annuity” and wonder what is meant, don't defer your question, ask immediately - “Immediate annuity or deferred annuity?”
Ernie McDaniel is a Chartered Financial Consultant and President of McDaniel Financial. He can be reached at 318-798-9022.
