What is a Wraparound Annuity?
A wraparound annuity is a deferred annuity that gives the annuitant or investors the right to choose the underlying investment in the annuity plan. Insurance companies offer annuity packages to individuals to provide them with a stable income after they retire. All Annuities are tax-deferred, the annuitant first makes a lump sum payment to the insurance company or can break the payment down. In exchange for the lump sum payment or series of payments, the annuitant is entitled to regular payment after retirement. A wraparound annuity allows the annuitant control or determine the category of investments that will be in the plan.
How Does a Wraparound Annuity Work?
One of the most reliable ways through which individuals secure a regular stream of income for life after retirement is through annuity. An annuity plan is a tax-deferred contract that insurance companies offer to interested individuals. Individuals make payment into the plan for a stipulated time after which they begin to reap the benefits of the annuity by receiving a steady payment at a specified time. A wraparound annuity gives the holder or the annuity plan the right but not an obligation to make the choice of the underlying investments in the annuity plan. Just like other forms of annuities, there is a period at which annuitants begin to receive payments, this is called the annuitization period.
IRS Ruling
At annuitization, holders of a wraparound annuity plan do not pay tax on any amount paid to them by the financial institution. These annuitants can also choose the make-up of the plan. However, overtime, the Internal Revenue Service discovered that many investors use the provision of wraparound annuity to choose investments to just evade tax payment, this is why investors are no longer permitted to choose underlying investments in a wraparound annuity. Investors are no longer permitted to shelter funds using the wraparound plan which is tax-deferred. The IRS introduced a new rule in 1981 in which withdrawals made from wraparound annuity can be subject to tax. Typically, an annuity is categorized into two, we have fixed annuities and variable annuities. For fixed annuities, annuitants are paid regular payments on a periodic basis. Variable annuities holders can either earn much or little cash flow in the future depending on the performance of the investments in the plan. Investors are at liberty to select their preferred annuity plan, while a fixed annuity offers steady payment to holders, variable annuities holders enjoy a less stable income. However, regardless of the annuity plan that investors choose, there is a guaranteed income after retirement. Annuity is best for adults who are close to retirement, it is not recommendable for young individuals who have cash needs.