“Annuities and retirement planning”

Annuities come in many different forms. There areimmediate and deferred annuities, with both fixed andvariable rates. However, whatever the type of annuity, all canbe classified as either qualified or nonqualified annuities.And the distinction is easy.

Qualified annuities are used in connection with tax-advantaged retirement plans, such as defined benefitpension plans, Section 403(b) retirement plans (TSAs), orIRAs. Premiums for qualified annuities are generally paidwith pretax dollars, as are any investments purchased for usein a qualified retirement plan.

By definition, any annuity not used to fund a tax-advantaged retirement plan or IRA is considered anonqualified annuity. Contributions to nonqualifiedannuities are made with after-tax dollars--premiums are notdeductible from gross income for income tax purposes.

In essence, then, the products are the same. It is theplacement in or out of a retirement plan (and the resultingtax treatment) that distinguishes one from the other.

As noted, contributions to a qualified annuity aredeductible to the individual or employer (and/or excludable fromthe income of the individual) at the time of contribution, as wouldbe any tax-advantaged retirement plan investment. When anannuity is in a retirement plan, the rules of the plan govern all taxmatters. Specifically, the special tax-deferral advantages ofannuities, and the unique tax penalties and tax treatment ofannuities at distribution, are superseded when used in aretirement plan by the tax rules governing all investments in suchplans. It is for this reason that many financial advisors questionthe use of deferred annuities in retirement plans.

Note: Although it is true that the tax-deferral advantageof annuities is redundant in a qualified plan, annuity products mayoffer other features, such as a guaranteed death benefit, that maymake them a viable investment option for a portion of a qualifiedplan portfolio.

The rules for nonqualified annuities are different inmany respects, because these products are purchased withafter-tax money.

If the nonqualified annuity is partially or fullysurrendered, the first dollars out are considered earnings, andall of the earnings are taxed at ordinary income rates. After allof the earnings have been distributed, the remaining portionthat represents the original investment in the annuity isreceived tax free.

If payments are taken in the form of an annuity payout(i.e., a distribution taken out over a predetermined period oftime), a portion of each payment is considered a return of theoriginal investment and is excludable from gross income, and aportion is considered earnings and taxed at ordinary incometax rates.

The percentages that are earnings and return of investmentare based on the type of payout at the age of the recipient.Note, too, that distributions taken before age 59½ aresubject to a 10 percent early withdrawal penalty tax onearnings.

Note: Variable annuities are long-term investmentssuitable for retirement funding and are subject to marketfluctuations and investment risk, including the possibility ofloss of principal. Variable annuities are sold by prospectus,which contains information about the variable annuity,including a description of applicable fees and charges.These include, but are not limited to, mortality and expenserisk charges, administrative fees, and charges for optionalbenefits and riders. The prospectus can be obtained fromthe insurance company offering the variable annuity orfrom your financial professional. Read it carefully before youinvest.