BUILDING YOUR FUTURE WITH ANNUITIES A CONSUMER'S GUIDE (NOTE: This publication was produced by the: Fidelity Investments, in cooperation with the Office of the Consumer Advisor and the Extension Service of the U.S. Department of Agriculture, and the Consumer Information Center of the U.S. General Services Administration - For a free copy, send your name and address to: Consumer Information Center - Dept. 571Z - Pueblo, CO 81009) The purpose of this booklet is to help you learn the basics of annuities. * What is an Annuity * How an Annuity Can Fit into a Retirement Savings Plan * Types of Annuities * Guaranteed Annuities * Variable Annuities * What to Consider When Buying an Annuity * Questions and Answers Travel . . . a second home . . . new hobbies and pursuits. We all dream about the time of life when we can take it easy. But a comfortable retirement doesn't just happen--and Social Security alone won't assure the kind of lifestyle you've worked hard to enjoy. You need to invest in your future. You can use a number of different "building blocks" to help save money for a comfortable retirement. Individual Retirement Accounts (IRAs), Keoghs, and company pension plans are all ways to put money aside for your retirement. But after you've taken advantage of these, you might consider an annuity, a tax- advantaged way to put aside money for retirement objectives. In fact, annuities may be among the best ways to create retirement income. They allow your savings to grow tax-deferred, building your nest egg faster than other investments. As you read through this pamphlet, you'll learn what an annuity is and how it works, the types of annuities, and how to shop for one. WHAT IS AN ANNUITY? An annuity is a way to set aside money during your working years and have it grow on a tax-deferred basis for your future use. When you are ready to retire, it can provide steady income that is guaranteed to last the rest of your life, regardless of how long you live. The way this works is that you invest money with an insurance company. The insurance company insures you against the risk that you will outlive your retirement savings. As an alternative, you can withdraw your money from your annuity in a single cash sum or in a series of withdrawals over a specified period. Annuities may be a good investment for many long-term goals, but several features make them especially well suited for retirement savings: * No Annual Investment Ceiling, You're free to set aside as much money each year as your retirement plans require. Other tax- advantaged plans such as IRAs should not be overlooked for retirement savings, but the amount you can contribute each year is limited. * The Power of Tax Deferral. Your money will grow faster than in a taxable vehicle with a similar rate of return for several reasons. Not only does interest accumulate tax-free until withdrawal, but funds you otherwise would have used to pay taxes remain in your account for additional earnings. What's more, if you wait until retirement to receive your annuity income, you may be in a lower tax bracket, further increasing the value of your investment. It is important to remember that annuities are designed for long- term objectives because should you withdraw your earnings from the annuity before age 59 1/2 (other than in the form of a lifetime income), not only will the earnings be taxed, but the Internal Revenue Service probably will impose a 10% penalty, as well. * Security for Your Family. If you die before distributions begin, your loved ones can receive the full value of your annuity. By naming a beneficiary, you may even bypass probate and eliminate the associated costs. * Simplicity. There are no annual IRS forms to file, and you won't need an entry on Form 1040 until you actually begin to withdraw your funds. HOW ANNUITIES FIT INTO A RETIREMENT SAVINGS PLAN Annuities can maximize the income you receive at retirement. The chart below shows a 50 year old man in the 33% tax bracket who puts $25,000 into a taxable investment and into a tax- deferred annuity. Both investments earn a 10% rate of return, and withdrawals are delayed until age 70. This chart is for illustrative purposes only. Of course, your own monthly income would depend on your investment results. After-Tax Retirement Income Starting at Age 70. From a $25,000 Investment Made at Age 50. Taxable Investment With Systematic Withdrawals From Age 70 to 90 $476/Month for 20 Years Annuity Starting at Age 70 $655/Month for Life Assumptions: Taxable Investment: At age 70, income is provided for 20 years by a systematic withdrawal of principal and interest. The taxable investment continues to earn a 10% rate of return after withdrawals have begun. After 20 years of withdrawals, both principal and investment gains will have been exhausted thus providing no income after age 90. Based on current mortality statistics, 28% of all healthy males and 42% of all healthy females would live beyond the 20 year withdrawal period. Guaranteed Lifetime Income Annuity: At age 70, income is provided from the annuity by electing a guaranteed lifetime income option; at death, income payments cease, and the remaining value reverts to the insurance company. Income payments are determined assuming a 10% rate of return, an annual 1% annuity charge (to be discussed later) and using a standard mortality table. The annuity income is reduced by $43 per month after the sixteenth year due to higher taxes. TYPES OF ANNUITIES The following chart summarizes ways to categorize annuities. WHEN HOW INVESTMENT INCOME IT IS BOUGHT PERFORMANCE BEGINS - Deferred - Single payment -Fixed - Immediate - Periodic payments -Variable When Income Begins: Deferred or Immediate You can put funds in an annuity and allow them to grow tax deferred for some future date. This is called a DEFERRED annuity. Or you can put funds in an annuity and begin to get a regular income from it right away. This is called an IMMEDIATE (or Income) annuity. If you buy a deferred annuity, you can choose to convert it to an immediate annuity at a future time of your choosing, often at retirement. There is a chart on page 12 of this booklet that gives a description of some of the more popular income options and how they compare. How It Is Bought: Single or Periodic Payments You can choose to buy your annuity with just a single sum. This is called a single payment (or single premium) annuity. Or, you can make a series of payments. This is called a periodic payment annuity or a flexible premium annuity. Immediate annuities are always purchased with a single sum. Deferred annuities may be purchased as a single sum or as a series of payments. Investment Performance: Guaranteed or Variable You can choose to have your annuity grow at a preset interest rate guaranteed by the insurance company. In addition, the company guarantees to return the amount of principal you paid in. This is called a fixed or guaranteed annuity. Or, you can choose a variable annuity and have your funds invested in a family of mutual funds. Variable annuities are also referred to as self directed annuities because you have the right to direct into which mutual fund portfolios your money goes. MORE ABOUT GUARANTEED ANNUITIES With a fixed or guaranteed annuity, you lock in an interest rate for an initial period, normally one to three years. When the period ends, the insurance company designates a new rate of return for the succeeding period. Always ask the insurance company representative for a rate history to see what the renewal rates have been. Most guaranteed annuities have a minimum guaranteed rate which will be paid regardless of economic conditions. Some guaranteed annuities contain a bailout clause allowing you to withdraw your money and close your account without a surrender charge if the interest rate is renewed below a certain level (See "What to Consider" for more information about bailout clauses and surrender charges). A bailout provision gives you added protection that a company won't offer high initial rates only to pay renewal rates that are much lower than market conditions would indicate. Remember, any earnings you withdraw before age 59 1/2 will be taxable at your current rate plus a 10% tax penalty. The security of your principal and earnings depends on the health of the issuing company. The full strength of the insurer stands behind the earnings rate guarantee; but, unlike a variable annuity, guaranteed annuity assets are invested in the company's general account and are subject to the claims of its creditors. That's why it is essential to do your homework. Be sure to ask the insurance company representative if the insurer is rated at least an ''A'' for its claims-paying ability by respected sources such as A.M. Best Co. and Standard Poor's. This is especially important if you're considering a high-yielding annuity, because a company's aggressive investing could put your own annuity assets at greater risk. MORE ABOUT VARIABLE ANNUITIES A variable annuity gives you a selection of investment options, typically a family of mutual funds. You, rather than the insurance company, decide in what type of investment(s) your annuity is allocated. For example, you can choose to have your money in aggressive or conservative stock portfolios or aggressive or conservative bond portfolios. You also have the right to transfer among portfolios tax-free as your objectives and market conditions change. Because of its added investment flexibility, a variable annuity could provide better protection against inflation than a guaranteed annuity. Variable annuities offer the potential to earn more than with a guaranteed annuity, but the value of your annuity can decrease also because no minimum earnings rate is guaranteed. Your rate of return will fluctuate as the value of your underlying mutual fund investment does. One major advantage of a variable annuity is that your assets are "walled off" from the insurance company's creditors. In the event the company has financial difficulties, your variable annuity cannot be used to satisfy its creditors. While the issuing insurance company is important in a variable annuity, the experience of the mutual fund investment manager is a critical factor to consider. When you're considering a variable annuity, always read the prospectus carefully before you invest. The prospectus has information about how your annuity works, including management fees, expenses and annuity charges. Clearly, each type of annuity has distinct advantages; choose the one that most closely matches your investment objectives and tolerance for risk. You may even be able to buy an annuity that has both variable and fixed accounts. WHAT TO CONSIDER While all annuities offer tax-advantaged savings and lifetime income, other charges and features that can affect the value of your annuity vary with the issuing company. Charges. Generally, charges associated with annuities pay for keeping accurate records on each contract and sending reports to annuity owners, marketing expenses, professionally managing the underlying investments, guaranteeing to pay lifetime income options, and keeping charges to owners below a preset level, even if the company incurs expenses which exceed the preset expense level. These charges include: * Surrender charge, or what the insurer will charge if you withdraw your funds before a certain period of time. This charge may be as much as 10%, and applies during the first five to ten years of your annuity contract. Some surrender charge time periods begin with the original contract date only, while others also apply to subsequent payments. * Annual charge, a charge for the cost of administering the annuity contract. Annual charges usually range from $25 to $40. * Guaranteed annuity fees and expenses are not expressed as separate charges (other than the two shown above). The interest rate quoted for them is the amount you receive after the insurance company deducts expenses from the rate it earns on the underlying investment. Because your principal and interest are guaranteed by the insurance company and you do not decide how the underlying assets are invested, guaranteed annuities don't use a prospectus. * Variable annuity fees and expenses are expressed separately. You can find them in the prospectus. Ask a company representative to explain them to you if you have questions. - Mortality and expense charge. This fee pays for the guarantee the company makes that you will never outlive your annuity income. It also makes it possible for the company to guarantee the expenses you pay will never exceed a certain amount even if the company's cost increases. Most companies charge 1% to 1.5% annually for variable annuity expenses. Expenses are customarily deducted at a rate of 1/365th of the annual charge each day. Variable annuity fees are frequently called mortality and expense risk charges and maintenance charges. - Investment expense charge. These expenses are similar to mutual fund expenses; they may range from 1/4% (.0025) to 2% (.02). Features. The following features can add to the value of your contract. However, they are not available in every annuity contract or the feature can vary by company--so be sure to ask about each feature as you investigate individual annuities. ALL ANNUITIES * Telephone privileges. Many companies have toll-free service numbers to provide you with information about your annuity. This is particularly important for variable annuities, which allow you to transfer assets among portfolios. GUARANTEED ANNUITIES * Bonus yield. Some companies offer limited-time bonuses in the form of higher interest rates or additions to your principal. However, be careful. The trade-off could be lower yields later, a large surrender charge or even restrictions on how your money can be withdrawn at retirement. * Bailout clause. Look for the conditions under which you're exempt from a surrender charge. VARIABLE ANNUITIES * Guaranteed Death Benefit. In the event you die before you begin withdrawing funds, your beneficiary will receive the greater of (1) the current market value of your annuity or (2) the amount you invested. This benefit helps protect against downward market fluctuations. * Dollar Cost Averaging. This is a simple investment strategy in which you invest equal amounts into the same portfolios every month over an extended period of time. Dollar cost averaging doesn't assure a profit or protect against loss in a declining market, but it will help ensure that you buy more when the price is low and less when it's high. That way, your cost per unit will always be less than the average unit price in up, down, or fixed markets. Dollar cost averaging can be set up to operate automatically. For the strategy to be effective, you should continue to invest in both market ups and downs. * Transfers Between Portfolios. Some annuities allow you to make unlimited free transfers among the mutual fund portfolios in your annuity; others may charge for the transfers or limit the amount you can make. As you can see, it pays to shop around--and to read the fine print. QUESTIONS AND ANSWERS Here are some common questions about annuities. Chances are, you'll have a few, too. Don't be afraid to ask the issuer's representative about annuities in general or about specific product features. When it comes to your hard-earned money no question is ever "silly." Q. I contribute to a pension plan where I work. Why bother with an annuity? A. Most people who retire with adequate income have used a building block approach. The building blocks are their pensions, Social Security and their personal savings. Many pension plans don't factor inflation into your retirement income, so you may end up with less real income than you expected. And Social Security was intended to supplement retirement savings, not do it all. These days, it's necessary to have personal savings as an additional income source. An annuity is among the more attractive options for adding to your retirement income. Q. Isn't an annuity the same as an IRA? A. Annuities and Individual Retirement Accounts both offer the benefit of tax-deferred earnings. But there are several differences. * While IRA contributions are restricted to $2,000 annually, you may put as much as you'd like in an annuity each year. Also, you can still fully fund your IRA or other retirement plan even if you also buy an annuity. However, unless you are using your annuity to fund an IRA, your contributions are not tax- deductible. * An annuity generally allows your investment to accumulate until age 80 or later. With an IRA, you're required to begin making minimum withdrawals at age 70 1/2 or face a tax penalty. * An annuity gives you the option of lifetime income; an IRA doesn't. Q. I'm 28 and hope to purchase my first home within the next three to four years. Would a tax-deferred annuity be a good way for me to save for my downpayment? A. Probably not. Annuities work best for people who are putting aside money for longer-term goals, especially retirement. If you were to take money out of an annuity in three or four years, you probably would pay a surrender charge imposed by the insurance company, as well as a 10% tax penalty. Q. When can I take my money out? A. You have access to your money any time, but it is subject to charges and penalties if you take it out too soon. Remember, however, that annuities--like IRAs--are designed for long term investing and are not suitable if you may need the money before you are 59 1/2 or before the surrender charge has expired. Q. What kind of choices will I have when I want to take my money out? A. You can take your money out in a single sum. You can also choose from a number of income options. The chart at the bottom of page 12 describes some of the more popular income options generally available. Q. How will my annuity payments be taxed? A. It depends on how you withdraw your funds. Tax treatment is different for annuities purchased with "before tax" dollars, such as many IRAs and most employer sponsored pension plans. When you buy an annuity with "after tax" dollars, you pay income tax only on the portion that represents earnings. Income Options: Generally, for tax purposes, a portion of each income payment you receive is considered principal (i.e., the amount you invested) and a portion is considered earnings (i.e., the amount by which the value of your annuity exceeds the amount you invested). With most income options, you have the advantage of spreading out your tax liability over a number of years. Single sum withdrawals: With most single sum withdrawals, it is assumed for tax purposes that you receive all of your earnings first and your original investment last. Consequently, you will pay your taxes "up front" rather than spread out over time. The formula used to determine these amounts is set by the Federal Government and is the same for all companies. Q. Why give an insurance company money just to have them give it back? A. There are two reasons why that makes sense when you're preparing for a comfortable retirement. * You can choose an annuity income option that will guarantee to pay you (or you and your spouse) income for the rest of your life, no matter how long you live. * An annuity is an efficient way to turn capital into income, primarily because of its tax advantages. Properly planned, an annuity will produce more spendable income for you than living off interest alone or trying to spread out systematic withdrawals from an investment over your lifetime. See the example under "How annuities fit into a retirement savings plan." Q. How can I make a wise annuity choice? A. Be an informed consumer before you buy. Compare the contracts of different companies. A little legwork now can make a big difference in the future. * Review this Consumer's Guide. * Read all the literature the company provides including any prospectus. Ask questions until you are completely satisfied that you have all the information you need to make an informed decision. * You may wish to seek the advice of your accountant or tax advisor. * Call your local USDA Cooperative Extension Office. * Your local library can also be a good source of information. * When you receive your contract, review it immediately. If you do not understand any part of it, call the company or the company representative at once. You have 10 days after receiving your contract to return it with no surrender charges. * If you have a problem with your company representative, write a letter clearly outlining your problem. Send it to the broker and to the issuing company. If that fails, contact your state's insurance department. A Comparison of Variable and Guaranteed Annuities Tax-deferred earnings Variable Guaranteed yes yes Variety of income options Variable Guaranteed yes yes Annual investment ceiling Variable Guaranteed no no Investment flexibility Variable Guaranteed yes no Potential for higher returns Variable Guaranteed yes no Increased investment risk Variable Guaranteed yes no Hedge against inflation Variable Guaranteed yes no Security of principal and earnings Variable Guaranteed no yes Guaranteed interest rate Variable Guaranteed no yes Control over what type of investment is in your annuity Variable Guaranteed yes no INCOME ANNUITY OPTIONS This chart gives you an approximate idea of how different income options compare. The amount of income you actually receive is based on factors such as how you invest your age your sex, and the income option you choose. Market conditions at any given time, especially interest rates, influence income amounts. INCOME OPTION/DESCRIPTION/COMMON USES/TYPICAL MONTHLY INCOME+ /Lifetime Income. Also called Life Income or Life Only. /You receive income payments for the rest of your life. The income ceases upon your death. /Provides the most income per dollar invested of any lifetime option. Frequently used by single people with limited sources of additional income. /$751.08 per month for life. INCOME OPTION/DESCRIPTION/COMMON USES/TYPICAL MONTHLY INCOME+ /Lifetime Income with a minimum number of payments guaranteed. Also called Life with Period Certain. /You receive income for the rest of your life. If you die before you receive a specific number of payments, your beneficiary will receive the balance of the number of income payments you choose. /Consider this option if you want a life income but dislike the risk of lost income in a case of premature death. People with heirs often consider this option. /$708.21 per month for life, 141 month minimum INCOME OPTION/DESCRIPTION/COMMON USES/TYPICAL MONTHLY INCOME+ /Lifetime Income for two people. Also called Joint and Survivor. /Income payments are received as long as either of the 2 people are alive. Upon the death of either person, income continues as a percentage of the original amount. Common percentages chosen for the survivor are 50%, 66 2/3% and 100%. /Often chosen by couples. 100% option is often used when there is little other income. 50% or 66 2/3% might be used when there is other income. Special Pension Maximization Program is usually available. Lifetime income with Period Certain and Installment Refund options are also available for joint income plans. /$619.12 per month, as long as at least one person in alive, assuming you choose the 100% option. The numbers above are hypothetical and your actual income may be different. Only a portion of each payment would be taxable. +Assumes a 65 year-old male with a 65 year-old spouse invests $100,000 and begins receiving income immediately. FOR MORE INFORMATION For additional information and brochures.. Consumer Information Catalog Pueblo, CO 81009 Cooperative Extension Office U.S. Department of Agriculture (USDA) (Your local office is listed under State, Federal, or County Government in the phone directory.) For more information about annuities... Fidelity Investments Insurance and Annuity Group 1-800-544-2442 Ext. 15. FIDELITY INVESTMENTS{R} Published by Fidelity Investments, in cooperation with the Office of the Consumer Advisor and the Extension Service of the U.S. Department of Agriculture, and the Consumer Information Center of the U.S. General Services Administration.