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Understanding How One Borrows Against One's Own Pension
One type of annuity advice people seek is how to borrow money against their own annuity. An annuity loan sounds like a weird concept because annuities are supposed to be pension-like, paying out to you over a long specified period of time. How can one extract a loan from it?
The first kind is the lump sum, and the second kind is the deferred. The deferred payment version permits one to build up value in the annuity by making period payments into the annuity funds over time. At the end of these payment deposits there is an accumulation of money and dispersals begin to the recipient. The lump sum version permits one to place a large amount all at once after which the dispersals begin immediately. Your savings are therefore locked up in one place. In principle you have access to the savings but only over the specified income period, and only one payment at a time. An annuity loan allows you access to the funds immediately. Visit our 'FAQ' page to learn more.
Convert Your Locked-up Savings Into Emergency Money
One can see why the concept of an annuity loan is not so strange. The person who puts money into a deferred annuity is locking up a large amount of savings into a single source. What if something unexpected happens and that person needs emergency cash? He or she might wish to borrow against the money in the annuity. This is where the concept of annuity loans comes from. For people who are in dire straits, there is another way to gain access to your funds and that is to sell your annuity.
401K, 403B and IRAs Have Similar Features
A similar concept exists for 401K and 403b retirement accounts, as well as for traditional IRA and Roth IRA accounts. In all four cases, a person intending to retire has put a large amount of money into a single source or fund. In the event of a medical emergency or perhaps loss of a job, the person will benefit from borrowing against his or her own savings.
Avoiding A Tax Loophole By Forcing People To Borrow
The reason that it is necessary to borrow rather than take money directly out is because of the tax-advantages of the annuity. In general money that is put into the fund is tax deductible, for the very reason that it is to be used only upon retirement (when it becomes taxed). However, using the funds before retirement would be an exploitation of this tax loop-hole. Therefore, one must borrow against the amount at some non-zero interest rate rather than use the money directly. Direct usage of the money is only done through a dispersement of funds.
The Issuing Company Sets The Terms
The insurance company responsible for setting up the original annuity is also in charge of setting the conditions of annuity loans. Insurance companies are the financial experts because a lot of the calculations involve estimating the probability that the account holder never claims some fraction of the fund, which is calculated from actuary and demographic tables.
There are some caveats when taking money out. If you fail to repay within a specified amount of time the money is treated as a withdrawal and thus subject to heavy penalties on top of annuity loan rates. Furthermore, the outstanding loan amount freezes your ability to transfer your funds to another company until debts are resolved. Unlike when first buying in, you will not be able to compare annuity rates to get the best terms of the loan because you are tied to the originating company.