Uses of Annuities

• Immediate Annuities
• Deferred Annuities

MR. WATSON: An immediate annuity , will begin paying to the annuitant a steady flow of income, within 30 days. It is funded with a lump sum deposit. It’s still earning interest, so the check you get each month will include principal and interest, but it was funded with a lump sum.

MR. WATSON: A deferred annuity , means you annuitize it sometime in the future. When you buy the annuity, do you need to tell me when you want to annuitize it?

MR. WATSON: No. Whenever you get good and ready to annuitize it, you can let the company know. (As a matter of fact, most annuities are never annuitized. Folks take withdrawals instead.) They use them strictly as savings accounts that pay higher interest rates than banks. Does that make sense?

STUDENTS: Yes.

MAN: I didn't understand the difference between withdraw and annuitize.

MR. WATSON: Withdraw means you take out some money, here and there, when you need it. Like you would with your savings account or the A.T.M.

MAN: So isn't that what an annuity is?

MR. WATSON: An annuity is just a bucket of money. It is designed to pay you a steady stream of income, monthly income and this is what our discussion is focusing on. Taking a steady stream of income for your lifetime is called annuitizing. But, again, most folks never annuitize their annuity. They buy it for the higher interest rates they pay and the deferral of taxes on the interest. Then, after a number of years, they simply take some of their money out as they need it (withdraw). But, it was designed to pay a steady stream of income, which is annuitizing. Do you agree?

MAN: Yes.

MR. WATSON: But you can also make withdrawals; like this month, I might take out $3,000, then maybe $4,000 next month. Pretty soon it's all gone. If I had annuitized instead, it would have paid me a lifetime of income, no matter how long I live.  Do you agree? That's the difference. I have choices.

MAN: Okay.

MR. WATSON: Yes, you can effectively annuitize it yourself just by taking withdrawals. But, if you continued doing that then eventually It would all be gone. But when you annuitize with an insurance company, you can't outlive it. The company takes the risk. So, if you have $12,000 in an annuity, you could withdrawal let’s say $1,000 a month until the money was gone. Or you could annuitize and get $1,000 a month for the rest of your life. So, if you lived for 14 months, you made out, because you got back more than what was actually in the annuity. Again, the 12 months life expectancy is just a silly example. For easy math. The insurance company would actually use a life expectancy table (mortality table). The amount of money you receive each month depends on certain factors, discussed in a minute.

STUDENT: Wow.

STUDENT: The penalty for early withdrawal - is that based on the amount you are withdrawing?

MR. WATSON: Yes. What is the penalty?

STUDENT: 10 percent.

MR. WATSON: It's 10 percent penalty on the total amount you withdraw. Also, withdrawals are taxed LIFO, Last In First Out, so the withdrawal comes from the interest first and once that’s exhausted then you get the principal tax-free, like we talked about a few minutes ago. But there is no 10% penalty for annuitizing - you can annuitize at any age and you will only pay income taxes on the interest. No 10% penalty.