There are several reasons that purchasing an annuity can be advantageous for estate planning purposes. First off, what are annuities? It's a fixed sum of money paid to someone each year, typically for the rest of their life. An annuity is an insurance product that pays out income, and can be used as part of a retirement strategy. Annuities are a popular choice for investors who want to receive a steady income stream in retirement.
Here's how an annuity works: you make an investment in the annuity, and it then makes payments to you on a future date or series of dates. The income you receive from an annuity can be doled out monthly, quarterly, annually or even in a lump sum payment.
Annuities, although typically an insurance company investment in the stock market, carry less risk because they provide periodic income for you to the rest of your life. Annuities also provide a death benefit to your named beneficiary if you die before receiving payments from your annuity. That has a built-in advantage for surviving families. Furthermore, annuities are also useful in that they allow your investment to grow tax-deferred.
If you simply invest your assets in the stock market, such as in the form of mutual funds, you risk losing your investment, which may result in you not having sufficient assets to live on for the rest of your life. Although annuities usually are invested in the stock market, you are guaranteed a certain amount of income for the remainder of your life, regardless of stock market fluctuations. In this respect, then, you can be assured that you will not lose a large chunk of your investments due to the stock market, and that you will have a fixed amount of income in the form of your annuity payments for the rest of your life.
Next, annuities are an effective estate-planning tool in that you must name a beneficiary and/or beneficiaries who will directly receive all or a portion of your annuity investment, depending on the terms of your annuity, without the need for formal probate proceedings. Like a life insurance policy, an individual retirement account (IRA), or a 401(k) plan, you simply name the person or persons that you wish to receive the annuity proceeds upon your death, and they will receive it, without losing some of the proceeds to probate lawyers and estate taxes.
As noted above, annuities are also an attractive investment option in that they allow your investment to grow tax-deferred until you begin receiving the periodic income payments set forth in your annuity. Plus, when you begin receiving payments from your annuity, you are taxed at the lower capital gains rate, as opposed to the regular income tax rate.
It is important to keep in mind, however, that annuities are only useful in this regard if your goal is to plan for your long-term future. Investing in an annuity for a period of less than ten years is likely to result in some loss of assets, rather than resulting in any sort of advantage. Moreover, if you must withdraw the value of your annuity investment prior to its payout period, you will be taxed at the regular income tax rate.
It is also important to keep in mind that there are other types of investments, such as 401(k) plans and IRAs, which may provide similar or even better tax advantages than annuities. Thus, it is extremely important to consult a tax advisor and/or an estate planning lawyer in order to determine whether purchasing an annuity would best meet your needs.
The information on this page is meant to provide a general overview of the law. The laws in your state and/or city may deviate significantly from those described here. If you have specific questions related to your situation you should speak with a local attorney.