What is an Annuity Loan? | Borrowing Against an Annuity

If you own an annuity product, you may decide to access some of its principal and interest value for emergencies or short-term funding needs. That’s where annuity loans come in. You may be able to take a loan directly from your annuity contract. Or you may be able to use the value of your annuity as collateral for an external loan.

Of course, if neither of these options suits you, your annuity may have provisions in it that allow for other ways to get the cash you need.

Why Take an Annuity Loan?

You might want to take out a loan using the money currently in your annuity if:

• You have an emergency need for cash, such as medical expenses, home repairs, a down payment on a home down payment, or support for a family member.
• You would prefer not to surrender your annuity, primarily because you would incur tax and surrender charge penalties that would lower your annuity’s value.

How an Annuity Loan Works

Let's review the basics of deferred annuities and non-qualified annuities before we delve into the question of loan provisions.

When you buy a deferred annuity, it grows for years or even decades. This is known as the accumulation period. After the accumulation period, you can decide to "annuitize" your annuity. Essentially, this converts your deferred annuity into an immediate annuity and starts the steady stream of income payments.

Note that you can only use a deferred annuity in its accumulation phase for an annuity loan. You can not take an annuity loan out on an immediate annuity although you may be able to sell the stream of income payments for a discounted lump sum.

A non-qualified annuity is an annuity you fund with post-tax dollars. This contrasts with a qualified annuity, which you fund with pre-tax dollars.

Some non-qualified annuities allow you to borrow money during the accumulation phase. On the other hand, annuity loans for qualified annuities are a bit more rare and complex.

Here are the loan options you may have. You may be able to:

• Take a loan from your annuity contract. With this option, you're essentially lending yourself money.
• Use the value of your annuity account to get an external loan from a bank or other institution. With this option, you're using the value of the annuity as collateral.

Let's examine each of these options and determine if there are other, more attractive alternatives.

Taking a Loan From Your Non-Qualified Annuity

Loans from non-qualified annuities don't trigger taxes or penalties. The contract spells out the specifics about the loan payback period and interest rate. Any interest you pay flows back into your contract and increases the cash value.

Taking a new loan from your non-qualified annuity is straightforward because the money is yours. Here's how to take a loan out from your non-qualified deferred annuity:

Determine if your annuity allows you to take out a loan. Call your annuity company and ask if your annuity has a loan provision option. Some annuities, including annuities from Canvas Annuity, do not allow for loans.

Ask for details. Be sure to ask about:

• The current interest rate for repayment.
• The annuity's maximum withdrawal amount or percentage.
• When loan repayment will begin.

Review the loan information. Decide whether the terms make sense for your unique situation. Take into account things like your current income and debt load. Knowing these figures will help you determine whether you will be able to repay the loan as scheduled.

Submit the application. Since you are borrowing your own money, you won’t need a credit check. Simply submit the application, and the insurance company will process the request.

Receive your approval. Your approval letter will contain the loan terms, including when repayment will begin, the loan interest rate, and the loan amount. There may be maximum and minimum loan amounts.

Sign the approval letter. If you understand and agree to the terms, sign the approval letter and return it to your insurance company.

Taking a Loan From Your Qualified Annuity

If you own a qualified annuity, you may still be able to borrow money. But there are unique rules. Loans can be taken within your qualified annuity without penalty or tax consequences if:

• The proceeds are paid back within 5 years.
• The loan is $50,000 or 50% of the vested account, whichever is less.
• The proceeds are used for a first-time home purchase.

In general, taking a loan from your qualified annuity may not be a good idea due to some unintended consequences. As a reminder, money in qualified plans is not included in your taxable income. You pay taxes on contributions and earnings when you receive annuity payouts.

But let’s say you take a loan from your qualified retirement plan. When you repay the loan, you're repaying it with money that's already been taxed. That after-tax money goes back into your annuity. When you begin to receive annuity distributions, you will have to pay federal income tax on the full distribution. This means you'll be paying tax twice on the same money.

Using Your Non-Qualified Annuity as Collateral For an External Loan

When you use your annuity account balance as collateral for a loan, the Internal Revenue Service (IRS) considers this loan amount as a “non-periodic distribution” or withdrawal from your annuity. So, even if you don’t take money out of your non-qualified annuity, the IRS will still see it that way and tax the amount as ordinary income. You could also be subject to a penalty tax if you’re under 59 1/2 years of age. In short, using your non-qualified annuity as collateral for a loan can cost you money.

Using Your Qualified Annuity as Collateral For an External Loan

Qualified annuities are typically part of a pension plan or an IRA. Loans are not permitted in an IRA for any reason. Annuities that are part of an IRA cannot be used as collateral.

What Are the Advantages of Taking a Loan From Your Annuity?

There are some advantages to taking an annuity loan.

Avoid surrender charges. An alternative to taking a loan is to surrender a portion or all of your annuity for cash. This is called “surrendering” your annuity. If you surrender your annuity during the surrender charge period, you'll have to pay surrender charges. These surrender charges can sometimes cancel any gains your annuity has accrued. With an annuity loan, you don't have to pay surrender charges.

Avoid taxes and early distribution penalties. An additional benefit is that you can avoid taxes and early distribution penalties by taking a loan. For example, if you liquidate your annuity before age 59 1/2, you’ll be charged a 10% early distribution tax penalty on the amount withdrawn. Taking out an annuity loan can help avoid these charges.

What Are the Drawbacks of a Loan From Your Annuity?

Although it is a relatively simple exercise to take out an annuity loan with the insurance company, there are some drawbacks.

You may incur an early distribution penalty. If you take out a loan, you must repay the minimum amount within the specified time frame. If you default on paying the annuity loan balance, it is considered a “distribution.” In that case, it is subject to an early distribution penalty from the insurance company. It's also subject to income tax by the federal government.

You'll reduce your earnings growth potential. By borrowing money against your annuity, you’re reducing the balance that’s available to earn interest. This reduces the earnings growth potential of the annuity product.

Potential Restrictions. While you can use your qualified annuity to access a loan, there are restrictions. Additionally, it may not be the best use of your tax-deferred status.

Other Ways to Get Money From Your Annuity

There is another way to access the value of your annuity without taking an annuity loan or paying significant penalties. You can take advantage of any annual “penalty-free” provision in your contract. Many annuities, including the annuities from Canvas Annuity, allow a generous 10% penalty-free withdrawal each year. Some annuities, like the Canvas Flex Fund, even allow a complete return of your initial premium without any penalty.

But remember that annuities, by their nature, are retirement products. Almost all have surrender charge penalties for early withdrawals, and the surrender charge period can last as long as 10 years. It is best to keep any money you may need for emergencies in more liquid investments like savings accounts.

Conclusion: Is an Annuity Loan a Good Idea?

In general, taking out an annuity loan, surrendering your annuity, or selling your annuity for a fraction of its worth are best reserved as last resort options.

If you’re able to, it's best to have emergency funds in more flexible products, like online savings accounts, that provide attractive interest rates and have no withdrawal penalties.

It's also a good idea to meet with a financial professional and/or tax advisor to get tax advice and discuss your objectives.

Finally, never deposit money in an annuity plan with the assumption that you may be able to take out an annuity loan. A significant advantage of annuities is that they provide guaranteed income. Plus, Canvas Annuity provides the flexibility of annual 10% penalty-free withdrawals and the possibility of a complete return of your initial premium. Take a look at how easy it is to buy a Canvas Annuity online today!