Ken Himmler.com

Investment planning during retirement is not the same as investing for retirement and, in many ways, is more complicated. Your working years are your saving years. With luck, your income increases from year to year as you receive promotions and/or pay raises; those increases offer some protection against rising costs caused by inflation. While you're working, your retirement objective generally is to grow retirement savings as much as possible, and investments that offer higher potential reward in exchange for greater potential for volatility and/or loss are often the focus for those retirement savings.

When you retire, on the other hand, spending rather than saving becomes your focus. Your sources of income may include Social Security, employer pensions, personal savings and assets, and perhaps some income from working part-time. Typically, a retiree's objective is to derive sufficient income to maintain a chosen lifestyle and to make assets last as long as necessary. This can be a tricky balancing act. Uncertainty abounds–you don't know how long you'll live or whether rates of return will meet your expectations. If your income is fixed, inflation could erode its purchasing power over time, which may cause you to invade principal to meet day-to-day expenses. Or, your retirement plan may require that you make minimum withdrawals in excess of your needs, depleting your resources and triggering taxes unnecessarily. Further, your ability to tolerate risk is lessened–you have less time to recover from losses, and you may feel less secure about your finances in general.

How, then, should you manage your investments during retirement given the above complications? The answer is different for everyone. You should tailor your plans to your own unique circumstances, and you may want to consult a financial planning professional for advice. The following discusses two important factors you should consider: (1) withdrawing income from retirement assets, and (2) balancing safety with growth.

Choosing a sustainable withdrawal rate
A key factor that determines whether your assets will last for your entire lifetime is the rate at which you withdraw funds. The more you withdraw, the greater the likelihood you'll exhaust your resources too soon. On the other hand, if you withdraw too little, you may have to struggle to meet expenses; also, you could end up with assets in your estate, part of which may go to the government in taxes. It is vital that you estimate an appropriate withdrawal rate for your circumstances, and determine whether you should adjust your lifestyle and/or estate plan.

Your withdrawal rate is typically expressed as a percentage of your overall assets, even though withdrawals may represent earnings, principal, or some combination of the two. For example, if you have $700,000 in assets and decide a 4 percent withdrawal rate is appropriate, the portfolio would need to earn $28,000 a year if you intend to withdraw only earnings; alternatively, you might set it up to earn $14,000 in interest and take the remaining $14,000 from the principal. An appropriate and sustainable withdrawal rate depends on many factors including the value of your current assets, your expected rate of return, your life expectancy, your risk tolerance, whether you adjust for inflation, how much your expenses are expected to be, and whether you want some assets left over for your heirs. Fortunately, you don't have to make a wild guess. Studies have tackled this issue, resulting in the creation of tables and calculators that can provide you with a range of rates that have some probability of success. However, you'll probably need some expert help to ensure that this important decision is made carefully.

Withdrawing first from taxable, tax-deferred, or tax-free accounts
Many retirees have assets in various types of accounts–taxable, tax-deferred (e.g., traditional IRAs), and tax-free (e.g., Roth IRAs). Given a choice, which type of account should you withdraw from first? The answer–it depends. Caution: Roth IRA earnings are generally free from federal income tax if certain conditions are met, but may not be free from state income tax.

Retirees who will not have an estate
For retirees who do not intend to leave assets to beneficiaries, the answer is simple in theory: Withdraw money from a taxable account first, then a tax-deferred account, and lastly, a tax-free account. This will provide for the greatest growth potential due to the power of compounding. In practice, however, your choices, to some extent, may be directed by tax rules. Retirement accounts, other than Roth IRAs, have minimum withdrawal requirements. In general, you must begin withdrawing from these accounts by April 1 of the year following the year you turn age 70½. Failure to do so can result in a 50 percent excise tax imposed on the amount by which the required minimum distribution exceeds the distribution you actually take.

Retirees who will have an estate
For retirees who intend to leave assets to beneficiaries, the analysis is more complicated. You need to coordinate your retirement plan with your estate plan.
If you have appreciated or rapidly appreciating assets, it may be more advantageous for you to withdraw from tax-deferred and tax-free accounts first. This is because these accounts will not receive a step-up in basis at your death, as many of your other assets will, and your heirs could face a larger than necessary tax liability.
Example(s): John is a widower with two children who retires at age 65. He has a tax-deferred pension plan valued at $200,000 and an investment portfolio holding appreciated shares of stock and bonds with a current value of $500,000 and a basis of $250,000. John's investment portfolio has been held long-term. Assume John is in the 15 percent tax bracket and his children are in the 33 percent tax bracket. Assume John's investment portfolio earns $25,000 each year, and assume no other variables. Say John dies four years later having made withdrawals totaling $100,000.

If John had withdrawn from his investment portfolio first, he would have paid $15,000 in federal ordinary income tax. His children would receive the $200,000 pension, on which they will have to pay federal ordinary income tax of $66,000. They would also receive the investment portfolio, which would receive a step-up in basis. Say the children sell the investment portfolio for $500,000 and owed no capital gains tax. In this scenario, the family (John and his children combined) pays $81,000 in federal taxes.

If John had withdrawn from his tax-deferred pension first, he would have paid $15,000 in federal ordinary income tax. His children would receive the $100,000 balance of the pension on which they would have to pay federal ordinary income tax of $33,000. They would also receive the $500,000 investment portfolio, which would receive a step-up in basis. Say the children sell the investment portfolio for $500,000 and owed no capital gains tax. In this scenario, the family (John and his children combined) pays $48,000 in federal taxes, $33,000 less than in the first scenario.

Caution: The example above is for illustrative purposes only and does not represent the performance of any investment. However, this may not always be the best strategy. For example, if you intend to leave your entire estate to your spouse, it may be better to withdraw from taxable accounts first. This is because spouses are given preferential tax treatment with regard to retirement plans. As a beneficiary of a traditional IRA or retirement plan, a surviving spouse can roll over retirement plan funds to his or her own IRA or retirement plan, or, in some cases, may continue the deceased spouse's plan as his or her own. The funds in the plan continue to grow tax deferred, and distributions need not begin until the spouse's own required beginning date. For retirees who have a "stretch" IRA, you may want to take advantage of your ability to defer taxes over a number of generations. Tip: Retirees in this situation should consult a qualified estate planning attorney who has some expertise with regard to retirement plan assets.

Balancing safety and growth
When you retire, you generally stop receiving income from wages, a salary, or other work-related activity and start relying on your assets for income. To ensure a consistent and reliable flow of income for your lifetime, you must provide some safety for your principal. This is why retirees typically shift at least a portion of their investment portfolio to more secure income-producing investments, and this makes a great deal of sense.

Unfortunately, safety comes with a price–reduced growth potential and erosion of value due to inflation. Safety at the expense of growth can be a critical mistake for some retirees. On the other hand, if you invest too heavily in growth investments, your risk is heightened, and you may be forced to sell during a downturn in the market should you need more income. Retirees must find a way to strike a reasonable balance between safety and growth.

One solution may be the "two bucket" approach. To implement this, you would determine your sustainable withdrawal rate (see above), and then reallocate a portion of your portfolio to fixed income investments (e.g., certificates of deposit and bonds) that will provide you with sufficient income for a predetermined number of years. You would then reallocate the balance of your portfolio to growth investments (e.g., stocks) that you can use to replenish that income "bucket" over time. The fixed income portion of your portfolio should be able to provide you with enough income (together with any other income you may receive, such as Social Security and required minimum distributions from retirement plans) to meet your expenses so you won't have to liquidate investments in the growth portion of your portfolio at a time when they may be down. This can help you ride out fluctuations in the market, and sell only when you think a sale is advantageous.

Be sure that your fixed income investments will provide you with income when you'll need it. One way to accomplish this is by laddering. For example, if you're investing in bonds, instead of investing the entire amount in one issue that matures on a certain date, spread your investment over several issues with staggered maturity dates (e.g., one year, two years, three years). As each bond matures, reinvest the principal to maintain the pattern.

As for the growth portion of your investment portfolio, common investing principles still apply:

•   Diversify your holdings
•   Invest on a tax-deferred or tax-free basis if possible
•   Monitor your portfolio and reallocate assets when appropriate

Caution: For retirees investing in bonds, don't assume that individual bonds and bond funds are the same type of investment. Bond funds do not offer the two key characteristics offered by bonds: (1) income from bond funds is not fixed–dividends change depending on the bonds the funds has bought and sold as well as the prevailing interest rate, and (2) a bond fund does not have an obligation to return principal to you when bonds within the fund mature. Additionally, the risk associated with bond funds varies depending on the bonds held within the fund at any given time, whereas the risk associated with individual bonds generally decreases over time as a bond nears its maturity date (assuming the issuer's financial situation doesn't deteriorate). Finally, fees and charges associated with bond funds reduce returns. Even so, you may still find bond funds attractive because of their convenience. Just be sure you understand the differences between bond funds and individual bonds before you invest.

You may have lost your job already, or it's something you're concerned about. Either way, the keys to surviving a job loss financially are to plan ahead, take stock of your income, and cut your expenses.

Plan ahead
If you haven't been laid off, it's a good idea to plan ahead for that possibility. It's hard to know how long you'll be out of work, so to be on the safe side, prepare for at least six months of unemployment. You might find a job much sooner, but you don't want to be forced to take the first opportunity that comes along, especially if it isn't suitable. Come up with a financial plan for unemployment, and design your plan with some flexibility to allow for adjustments if your situation changes. Circumstances can vary based on how long you're out of work, and whether unanticipated expenses arise while you're unemployed.

Prepare a survival budget
A big part of your unemployment plan is a survival budget. Start with a list of all your income and expenses. You might already have a budget that you can use as a base, but your survival budget should be a bare-bones version of your regular budget. Include only expenses that are necessary. The goal of your survival budget is to have a good idea of what income you need to actually survive. Your plan also should include an emergency fund that's equal to at least six months of living expenses from which you can draw to supplement other sources of income. If you haven't set up an emergency fund, you may still have time to do so. You'll be amazed how fast you can deplete your regular savings if your unemployment lasts more than a couple of weeks.

If you lose your job, find some income
Start by checking with your former employer. Are you eligible for severance pay? Whether it's available depends on your employer's policy, but if you're offered severance pay, you might have the option of taking it in a lump sum or as a continuation of salary for a fixed period of time. Taking severance pay in a lump sum gives you control over your money, but you may lose some employee benefits such as group health insurance. If you take your severance as a continuation of salary, you may be able to keep your benefits, but you'll be dependant on your former employer's ability to make payments to you. But don't stop there. Check with your local unemployment office to find out if you're eligible for unemployment benefits. You can receive at least 26 weeks of benefits (more in some cases). Generally, to qualify for unemployment benefits you must have been laid off. You may even qualify if you've been fired, so long as it's not for misconduct. You probably won't qualify if you quit your job, however.

Reduce your expenses
If you're unemployed, you may find that your income won't support your current expenses. Aside from reducing your debt by selling big-ticket items like your car or house, there are other things you can do to minimize your living expenses. One of your first considerations should be to identify and discontinue discretionary expenses. Such items as magazine subscriptions, health club memberships, extra phone services, credit cards you don't use that have an annual fee, dining out regularly, and extra pay services on your cable television are examples of some of the expenses you can trim from your budget. You also may have to put off that planned vacation until you're back on your "working" feet.

Talk with your creditors
Another way to cut your expenses is to try negotiating with your creditors to lower interest rates on your credit cards, defer a payment or two on your car loan, or reduce your monthly payments temporarily. You also may be able to lower your home mortgage monthly payments by refinancing to a lower rate (if you can qualify in spite of your job loss), or by negotiating a longer repayment period. You'll have to admit that you're facing some financial difficulty due to your job loss, but if your credit is good, now's the time to make the calls–not when you fall behind in your payments. Along those same lines, check with your mortgage company or credit card companies or look at your billing statements to find out if you have credit insurance. Credit insurance will make your bill payments when you're unemployed. However, you may have to wait a while before receiving benefits.

While technically not an expense, you can also decrease your spending by reducing your contributions to retirement or education funds. However, the less you contribute now, the less you'll have for retirement or college, so this option should be a last resort. But you might be able to make up for the reduction in contributions by increasing payments to those funds when you're back on your feet financially.

Increase your income
You've cut your expenses and spending as much as possible, but you still don't have enough income. Here are some ideas that might help you meet your expenses while unemployed. Consider a part-time or temporary job. This will provide another source of supplementary income while you search for your next full-time job. And your part-time job could turn out to be your next full-time job–or at least it might lead to another opportunity with another potential employer. Also, your spouse or partner may be able to get a job if he or she is not already working, or pick up more hours at a present job.

Another income-generating option is borrowing from the cash value of your life insurance policies. But you'll be limited as to how much you can borrow by the amount of cash available and other policy restrictions. And you'll be charged interest on the borrowed funds, so if you don't repay the loan, it can reduce your death benefit or even cause the insurance to lapse.

If you're really strapped
Your home is another source of savings you may be able to tap into. If you have enough equity in your home, sometimes you can obtain a home equity line of credit even if you've lost your job. You'll only pay interest on the portion you use. But you'll still have to make a monthly payment, so make sure you're able to afford the new loan payments before you put your house on the line.

If you're still strapped for cash, consider withdrawing from your tax-deferred retirement accounts, such as your IRA or employer-sponsored retirement Any money you withdraw from these types of accounts likely will be taxed as ordinary income for the year in which you make the withdrawal. Also, you may have to pay a 10% penalty tax for early withdrawal if you're under age 59½ unless an exception to the penalty applies.

Tip: If you're considering taking funds from your IRA or retirement plan, you should consult a tax advisor regarding the specific tax treatment of your withdrawal, because not all of it will necessarily be taxable. For example, if part of the withdrawal from your traditional IRA or employer's retirement plan represents nondeductible contributions, you may not be taxed on that portion of the withdrawal.

If all else fails
If money really starts getting tight, be prepared to take more drastic steps. You might consider moving from your home and renting it temporarily. Obviously you'd have to find cheaper alternative housing, but the rental income from your home may be enough to cover your rental expenses while your tenants pay for most of the home costs, such as utilities and even real estate taxes. However, any decision you make in this area should be made with careful consideration, and only after evaluating how much you can actually get out of the deal.

As a last resort, you may have to consider selling bigger items like your car or even your home. Since these larger possessions usually carry a debt, by selling them you're not only generating some cash, but you're decreasing your expenses by ridding yourself of the debt attached to the item sold. All is not lost. A job loss is not the end of the world, even though it may feel that way. Mapping out your priorities and drafting a bare-bones budget can help you come up with your own financial strategy for job loss survival.
 

 When you die, you leave behind your estate. Your estate consists of your assets–all of your money, real estate, and worldly belongings. Your estate also includes your debts, expenses, and unpaid taxes. After you die, somebody must take charge of your estate and settle your affairs. This person will take your estate through probate, a court-supervised process that winds up your financial affairs after your death. The proceedings take place in the state where you were living at the time of your death. Owning property in more than one state can result in multiple probate proceedings. This is known as ancillary probate.

How does probate start?
If your estate is subject to probate, someone (usually a family member) begins the process by filing an application for the probate of your will. The application is known as a petition. The petitioner brings it to the probate court along with your will. Usually, the petitioner will file an application for the appointment of an executor at the same time. The court first rules on the validity of the will. Assuming that the will meets all of your state's legal requirements, the court will then rule on the application for an executor. If the executor meets your state's requirements and is otherwise fit to serve, the court generally approves the application.

What's an executor?
The executor is the person whom you choose to handle the settlement of your estate. Typically, the executor is a spouse or a close family member, but you may want to name a professional executor, such as a bank or attorney. You'll want to choose someone whom you trust will be able to carry out your wishes as stated in the will. The executor has a fiduciary duty–that is, a heightened responsibility to be honest, impartial, and financially responsible. Now, this doesn't mean that your executor has to be an attorney or tax wizard, but merely has the common sense to know when to ask for specialized advice.

Your executor's duties may include:

•   Finding and collecting your assets, including outstanding debts owed to you
•   Inventorying and appraising your assets
•   Giving notice to your creditors (e.g., credit card companies, banks, retail stores)
•   Filing an estate tax return and paying estate taxes, if any
•   Paying any debts or other taxes
•   Distributing your assets according to your will and the law
•   Providing a detailed report of how the estate was settled to the court and all interested parties

The probate court supervises and oversees the entire process. Some states allow a less formal process if the estate is small and there are no complicated issues to resolve. In those states allowing informal probate, the court may be involved only indirectly. This may speed up the probate process, which can take years.

What if you don't name an executor?
If you don't name an executor in your will, or if the executor can't serve for some reason, the court will appoint an administrator to settle your estate according to the terms of your will. If you die without a will, the court will also appoint an administrator to settle your estate. This administrator will follow a special set of laws, known as intestacy laws, that are made for such situations.

Is all of your property subject to probate?
Although most assets in your estate may pass through the probate process, other assets may not. It often depends on the type of asset or how an asset is titled. For example, many married couples own their residence jointly with rights of survivorship. Property owned in this manner bypasses probate entirely and passes by "operation of law." That is, at death, the property passes directly to the joint owner regardless of the terms of the will and without going through probate. Other assets that may bypass probate include:

•   Investments and bank accounts set up to pass automatically to a named person at death (payable on death)
•   Life insurance policies with a named beneficiary (someone other than the estate)
•   Retirement plans with a named beneficiary
•   Other property owned jointly with rights of survivorship
   

As the cost of a college education continues to climb, many grandparents are stepping in to help. This trend is expected to accelerate as baby boomers, many of whom went to college, become grandparents and start gifting what's predicted to be trillions of dollars over the coming decades. Helping to pay for a grandchild's college education can bring great personal satisfaction and is a smart way for grandparents to pass on wealth without having to pay gift and estate taxes. So what are the best ways to accomplish this goal?

Outright cash gifts
A common way to help with college costs is to make an outright gift of cash or securities. But this method has drawbacks. If you gift the money directly to your grandchild, he or she might spend it on something other than college. Also, a gift of more than the annual federal gift tax exclusion amount–$13,000 for individual gifts, $26,000 for joint gifts–might have gift tax and generation-skipping transfer tax (GSTT) consequences (GSTT is an additional gift tax imposed on gifts made to someone who is more than one generation below you). Note that the $13,000 figure is for 2010. The exclusion is indexed for inflation, so this figure may increase in future years.

Another drawback to outright gifts is that a gift becomes an asset of the student, and the federal government treats student assets more harshly than parent assets for financial aid purposes. Students must contribute 20% of their assets each year toward college costs, compared to 5.6% for parent assets. Fortunately, there are better options available.

529 plans
A 529 plan can be an excellent way for grandparents to contribute to a grandchild's college education, while simultaneously paring down their own estate. Contributions to a 529 plan grow tax deferred, and withdrawals used for the beneficiary's qualified education expenses are completely tax free at the federal level (and at the state level too).

There are two types of 529 plans: college savings plans and prepaid tuition plans. College savings plans are individual investment-type accounts offered by nearly all states and managed by financial institutions. Funds can be used at any accredited college in the United States or abroad. Prepaid tuition plans allow prepayment of tuition at today's prices for the limited group of colleges–typically in-state public colleges–that participate in the plan.

Grandparents can open a 529 account and name a grandchild as beneficiary (only one person can be listed as account owner, though), or they can contribute to an existing 529 account. Grandparents can contribute a lump sum to a grandchild's 529 account, or they can contribute smaller, regular amounts.

Regarding lump-sum gifts, a big advantage of 529 plans is that under special rules unique to 529 plans, individuals can make a lump-sum gift of up to $65,000 ($130,000 for joint gifts by married couples) and avoid federal gift tax. A special election must be made to treat the gift as if it were made in equal installments over a five-year period, and no additional gifts can be made to the beneficiary during this time.
Example: Mr. and Mrs. Brady make a lump-sum contribution of $130,000 to their grandchild's 529 plan in Year 1, electing to treat the gift as if it were made over 5 years. The result is they are considered to have made annual gifts of $26,000 ($13,000 each) in Years 1 through 5 ($130,000 / 5 years). Because the amount gifted by each spouse is within the annual gift tax exclusion, the Bradys won't owe any gift tax (assuming they don't make any other gifts to their grandchild during the 5-year period). In Year 6, they can make another lump-sum contribution and repeat the process. In Year 11, they can do so again.

Significantly, this money is considered removed from your estate, even though one grandparent can still retain control over the funds if he or she is the 529 account owner. There is a caveat, however. If the donor were to die during the five-year period, then a prorated portion of the contribution would be "recaptured" into the estate for estate tax purposes.

Example: In the previous example, if Mr. Brady were to die in Year 2, his total Year 1 and 2 contributions ($26,000) would be excluded from his estate. But the remaining portion attributed to him in Years 3, 4, and 5 ($39,000) would be included in his estate. The contributions attributed to Mrs. Brady ($13,000 per year) would not be recaptured into the estate.

Another attractive feature of 529 plans is that under current law, grandparent-owned 529 accounts are excluded by the federal government's financial aid formula–only parent-owned 529 plans count. So a grandparent-owned 529 plan won't impact a grandchild's chances of qualifying for federal aid.

However, if you need the money in your 529 account for something other than the beneficiary's college expenses–for medical expenses or emergency purposes, for example–you'll face a double consequence: the earnings portion of the withdrawal is subject to a 10% penalty and will be taxed at your ordinary income tax rate.  Also, note that funds in a grandparent-owned 529 plan may still be factored in when determining Medicaid eligibility, unless these funds are specifically exempted by state law.cifically exempted by state law.
 

Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.

Pay the college directly
Another excellent way for grandparents to help their grandchildren with college costs is to pay the college directly. Under federal law, tuition payments made directly to a college aren't considered taxable gifts, no matter how large the payment. So you don't have to worry about the $13,000 annual federal gift tax exclusion. But this is true only for tuition–room and board, books, fees, equipment, and other similar expenses don't qualify. Aside from the obvious tax advantage, paying tuition directly to the college ensures that your money will be used for education, plus it removes the money from your estate. And you are still free to give your grandchild a separate tax-free gift each year up to the $13,000 limit.

However, colleges will often reduce a student's financial aid by the amount of the grandparent's payment. Before sending a check, ask the school how it will affect your grandchild's eligibility for school-based aid. If your contribution will adversely affect your grandchild's financial aid package, another option is to give the money to your grandchild after graduation to help him or her pay off student loans.

Private elementary/secondary school
Finally, if you're interested in contributing to your grandchild's private elementary or secondary school education, a Coverdell education savings account (ESA) can help. Up to $2,000 per beneficiary can be contributed to a Coverdell ESA each year. Like funds in a 529 plan, the money grows tax deferred and is tax free at both the federal and state levels if used to pay the beneficiary's qualified education expenses, including private elementary and secondary school as well as college. But there are income limitations on who can contribute to an ESA. Specifically, married couples with a modified adjusted gross income over $220,000 ($110,000 for individuals) can't contribute.
 

A fixed annuity is a contract between you and an annuity issuer, usually an insurance company. In its simplest form, you pay money to the annuity issuer; the issuer invests the funds and pays the principal and its earnings back to you or to your named beneficiary. What's fixed about a fixed annuity? The issuer guarantees (subject to its claims-paying ability) a minimum rate of interest on your investment and a fixed benefit amount if you elect to annuitize.

When is an annuity appropriate?
Annuity contributions are made with after-tax dollars and are not tax deductible. That's why it's often advisable to fund other retirement plans first. However, if you've already contributed the maximum allowable amount to other plans and want to save more toward your retirement, an annuity can be an excellent choice. There's no limit to how much you can invest in an annuity, and the funds grow tax deferred until you begin taking distributions.

Once you begin withdrawing from your annuity, you'll pay taxes (at your regular income tax rate) only on the earnings, since your contributions to principal were made with after-tax dollars. Like a qualified retirement plan, a 10% tax penalty may be imposed if you withdraw from an annuity before age 59½.

Annuities are designed to be very-long-term investment vehicles. In most cases, if you take a withdrawal, including a lump-sum distribution of your annuity funds within the first few years after purchasing your annuity, you may be subject to surrender charges imposed by the issuer. However, many companies allow options for withdrawals or distributions without incurring a charge. As long as you're sure you won't need the money until at least age 59½ and you understand the costs (including fees) involved, an annuity is worth considering.

Two distinct phases to an annuity
There are two distinct phases to an annuity contract: the accumulation phase and the distribution phase. In the accumulation phase, you're putting money into the annuity. You can choose to pay your premiums in one lump sum, or you can make a series of payments over time. These payments can be of equal amounts made at equal intervals, or of variable amounts at irregular intervals, depending on the terms of the contract.

Annuities may be either immediate or deferred; the terms simply refer to when the distribution phase begins. Immediate annuities are typically purchased with a single payment and the distribution phase usually begins within a year of the purchase. While deferred annuities may be purchased with a single lump sum premium payment, they are most often purchased with a series of periodic payments. The distribution period is deferred until some time in the future.

In the distribution phase, you begin taking money out of the annuity. You may withdraw some or all of the money in lump sums, or you may annuitize. Subject to the claims-paying ability of the issuer, annuitization provides a guaranteed income stream for either a specified period or for life.

How a Fixed Deferred Annuity Works

1. In the accumulation phase, you (the annuity owner) send your premium payment(s) (all at once or over time) to the annuity issuer. These payments are made with after-tax funds, and you may invest an unlimited amount.
2. The annuity issuer places your funds in its general account.* Your annuity contract specifies how your principal will be returned as well as what rate(s) of interest you'll earn during the accumulation phase. Your contract will also state what minimum interest rate applies.**
3. The compounding interest on your annuity accumulates tax deferred. You won't be taxed on these earnings until funds are withdrawn or distributed.
4. The issuer may collect fees to manage your annuity account. You may also have to pay the issuer a surrender fee if you withdraw money in the early years of your annuity.
5. Your annuity contract may contain a guaranteed** death benefit or other provisions for a payout upon the death of the annuitant. (The annuitant provides the measuring life used to determine the amount of the payments if the annuity is annuitized. As the annuity owner, you're most often also the annuitant, although you don't have to be.)
6. If you make a withdrawal from your deferred annuity before you reach age 59½, you'll not only have to pay tax (at your ordinary income tax rate) on the earnings portion of the withdrawal, but you may also have to pay a 10 percent premature distribution tax, unless an exception applies.
7. After age 59½, you may make withdrawals from your annuity without incurring any premature distribution tax. Since annuities have no minimum distribution requirements, you don't have to make any withdrawals. You can let the account grow tax deferred for an indefinite period. However, your annuity contract may specify an age at which you must begin taking income payments.
8. To obtain a guaranteed** fixed income stream for life or for a certain number of years, you could annuitize which means exchanging the annuity's cash value for a series of periodic income payments. The amount of these payments will depend on a number of factors including the cash value of your account at the time of annuitization, the age(s) and gender(s) of the annuitant(s), and the payout option chosen. Usually, you can't change the payments once you've begun receiving them.
9. You'll have to pay taxes (at your ordinary income tax rate) on the earnings portion of any withdrawals or annuitization payments you receive.

* These funds are invested as part of the general assets of the issuer and are therefore subject to the claims of its creditors.
** All guarantees are subject to the claims-paying ability of the issuing company.