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Introduction to the Uses of Annuities

Annuities can be powerful financial planning tools. Most often used as an insurance product, an annuity can also be used as an investment vehicle, as a way to turn lump-sum income into a stream of payments, and as a way to make a charitable gift while providing for your own financial security.

For this discussion, it’s assumed that investors understand how an annuity works, but a quick review of some pertinent points may be helpful. Essentially, annuities work like this:

  • You make premium payments with after-tax dollars (Note: we’re only discussing nonqualified annuities here)
  • Your money may be invested in a variety of investment vehicles (i.e., subaccounts) that you choose
  • You can switch money among various subaccounts without triggering taxes
  • Earnings grow tax-deferred until they are withdrawn (but if funds are withdrawn before age 59½, you may also incur a 10 percent federal penalty tax)
  • Earnings are taxed as ordinary income, not capital gains
  • You can make withdrawals from the annuity, or you can receive regular periodic payments for life (i.e., annuitize)
  • You can contribute as much as you want until you annuitize
  • Fees and charges are typically quite high
Retirement funding

Individuals most often use annuities as a supplement to a retirement savings plan because they can guarantee a fixed income stream for life. However, because contributions to annuities are made with after-tax dollars and because annuities tend to charge high fees that reduce earnings, they are typically used only after an individual has already contributed the most he or she can to other tax-deductible and tax-deferred retirement plans (e.g., employer-sponsored retirement plans, and individual retirement accounts (IRAs)).

But if you’re looking for an additional tax-deferred retirement savings opportunity, an annuity may be the answer. Why? Besides offering insurance that you won’t outlive your savings and tax deferral on earnings, annuities allow unlimited contributions and do not have minimum distribution requirements at age 70½ (unlike some employer-sponsored retirement plans and traditional IRAs).

Caution: Guarantees are subject to the claims-paying ability of the annuity issuer.
Charitable gifting

A charitable gift annuity (CGA) allows an individual to provide for his or her own financial security while making a gift to a charity and enjoy the accompanying tax benefits. A CGA is part gift and part annuity contract with the charity. You make an irrevocable gift of cash, marketable securities, or other property to the charity. In return, you (and/or a second beneficiary) receive a fixed income for life (not for a period of years) in the form of annually, semi-annually, or quarterly payments. You get an immediate income tax deduction (the size of which is determined by IRS actuarial tables). The annuity payments you receive are tax-exempt to the extent they represent return of principal (any portion that represents appreciation is taxable at capital gains tax rates; any portion that represents interest earnings is taxable at ordinary income tax rates). The property will not be included in your estate at your death, avoiding estate taxes.

Caution: A CGA is not a trust. With a CGA, the charity guarantees the annuity (subject to the charity’s claims-paying ability). With a trust, annuity payments are made from trust assets. For more information, see our separate topic discusssion, Charitable Remainder Annuity Trust (CRAT).

For personalized financial planning tailored to your needs and goals, contact Scarlet Oak Financial Services today. Whether you’re considering annuities for retirement funding, emergency provisions, income stream optimization, education savings, or charitable gifting, our experienced advisors are here to guide you.

Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here.  Click here to sign up for our newsletter with the latest economic news.


Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.

Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.