When a client qualifies for VA and/or Medicaid benefits, an annuity typically becomes part of the planning strategy. So what is an annuity?
Annuities generally come in two forms, either a tax-deferred annuity ("TDA") or a single premium immediate annuity ("SPIA"). A TDA is purchased from an insurance company through an insurance agent, and is designed to pay a guaranteed rate of interest for a set number of years. The TDA remains as a pile of cash, and continues to grow tax deferred until the owner elects to take a withdrawal. When compared to a taxable investment like a certificate of deposit, the TDA has a distinct advantage in that it will grow at a much faster rate. This is because none of the account value is lost to income taxes during its buildup phase. As a result of VA and Medicaid planning, shorter term TDAs have become available; it is possible to obtain a TDA with only a two- or three-year term.
When the owner elects a withdrawal from a TDA, the withdrawal amount is subject to taxation, but only to the extent of the deferred growth. In other words, the annuity contract operates on a "last in first out" formula. For example, if Robert purchase a single premium TDA with $50,000 and the contract value subsequently grows to $53,000, if he withdraws $4,000 he will be taxed on $3,000. The balance of the withdrawn amount is a return of his original investment - not a taxable event. Furthermore, if the owner is less than 59.5 years of age at the time of the withdrawal, and is not disabled, the taxable portion of the withdrawal will be subject to a 10% penalty tax. Additionally, to further limit withdrawals during a TDAs contracted term, the insurance company will impose a surrender charge if the owner tries to take more than 10% of the contract value in a single year. The surrender charge starts out high - 6% in year one of the annuity contract, and reduces 1% per year until the surrender charge is 0%.
The second form of an annuity, a SPIA, usually comes about when an existing TDA is annuitized - the owner retires and needs a guaranteed monthly income. However, like a TDA, a SPIA can be purchased from an insurance company, through an insurance agent. Unlike a TDA, which is a pile of cash, a SPIA is structured to pay a specified monthly payment, consisting of proportionate share of interest and principal, for a set number of years - period certain. Once a SPIA is established, it cannot be surrendered or converted to cash. The owner's only right is to continue to collect the monthly payments. However, if an owner is adamant about getting out from under the SPIA contract, the only way to resolve the matter is to sell it on the secondary market - a discount will apply. As for taxes, each year the owner will receive a 1099-R from the insurance company, which will report the total payments received, and the portion that is taxable.
Most insurance companies offer a SPIA with a period certain between five and 30 years, a few insurance companies offer a SPIA as short as three years, and only one insurance company dominates the market in the 2-23 month range. As a result of VA and Medicaid planning, shorter term SPIAs have become the norm.
Annuities generally come in two forms, either a tax-deferred annuity ("TDA") or a single premium immediate annuity ("SPIA"). A TDA is purchased from an insurance company through an insurance agent, and is designed to pay a guaranteed rate of interest for a set number of years. The TDA remains as a pile of cash, and continues to grow tax deferred until the owner elects to take a withdrawal. When compared to a taxable investment like a certificate of deposit, the TDA has a distinct advantage in that it will grow at a much faster rate. This is because none of the account value is lost to income taxes during its buildup phase. As a result of VA and Medicaid planning, shorter term TDAs have become available; it is possible to obtain a TDA with only a two- or three-year term.
When the owner elects a withdrawal from a TDA, the withdrawal amount is subject to taxation, but only to the extent of the deferred growth. In other words, the annuity contract operates on a "last in first out" formula. For example, if Robert purchase a single premium TDA with $50,000 and the contract value subsequently grows to $53,000, if he withdraws $4,000 he will be taxed on $3,000. The balance of the withdrawn amount is a return of his original investment - not a taxable event. Furthermore, if the owner is less than 59.5 years of age at the time of the withdrawal, and is not disabled, the taxable portion of the withdrawal will be subject to a 10% penalty tax. Additionally, to further limit withdrawals during a TDAs contracted term, the insurance company will impose a surrender charge if the owner tries to take more than 10% of the contract value in a single year. The surrender charge starts out high - 6% in year one of the annuity contract, and reduces 1% per year until the surrender charge is 0%.
The second form of an annuity, a SPIA, usually comes about when an existing TDA is annuitized - the owner retires and needs a guaranteed monthly income. However, like a TDA, a SPIA can be purchased from an insurance company, through an insurance agent. Unlike a TDA, which is a pile of cash, a SPIA is structured to pay a specified monthly payment, consisting of proportionate share of interest and principal, for a set number of years - period certain. Once a SPIA is established, it cannot be surrendered or converted to cash. The owner's only right is to continue to collect the monthly payments. However, if an owner is adamant about getting out from under the SPIA contract, the only way to resolve the matter is to sell it on the secondary market - a discount will apply. As for taxes, each year the owner will receive a 1099-R from the insurance company, which will report the total payments received, and the portion that is taxable.
Most insurance companies offer a SPIA with a period certain between five and 30 years, a few insurance companies offer a SPIA as short as three years, and only one insurance company dominates the market in the 2-23 month range. As a result of VA and Medicaid planning, shorter term SPIAs have become the norm.
