Beginner’s Guide to Annuities

Learning more about annuities can help you understand what options are available to you. Below are the answers to questions that many investors similar to yourself, have asked our licensed annuity experts.

An annuity is a contract between you and your insurance company that allows your earnings to grow and compound tax-deferred. Tax deferral is a powerful benefit you can use to help accumulate wealth for your retirement or meet other long-term financial goals. The word “annuity” literally means “annual payments.” Annuities are a popular choice for investors who want to receive a steady stream of income in retirement. The income you receive from an annuity can be distributed monthly, quarterly, annually or even in a lump sum payment. The size of your payments are determined by a variety of different factors including the length of your payment period.

An annuity has an accumulation phase as well as a payout phase. When you buy an annuity, the insurance company agrees to pay you an income for a specified period of time; either beginning immediately (an immediate annuity) or after an accumulation period ends (a deferred annuity).

Anyone who considers buying an annuity should do ample research and consult with an annuity professional to ensure that it’s an appropriate investment for someone in their situation.

In general, there are four parties to an annuity: the owner, the annuitant, the annuitant’s beneficiary and the insurance carrier.

The owner controls incidents of ownership in an annuity and has the right to the cash surrender value. The owner also can name the beneficiary, assign the policy, and make withdrawals. Often, the owner is also the annuitant.

Most importantly, the owner is the party who receives the tax benefit of the annuity during the accumulation phase of the contract. The owner does not pay annual taxes on the interest earned (the tax deferral); however, the owner may pay taxes on withdrawals made during the accumulation phase. The owner is typically the person who receives the payments during the income phase.

The annuitant is the person on whose life the terms of the annuity are measured. Again, the annuitant may also be the owner. This means that when the annuitant dies, the annuitant’s beneficiary is the recipient of the death benefit.

There are two main types of annuities: deferred and immediate.

With an immediate annuity, your income payments start right away. You choose whether you want income guaranteed for a specific number of years or over your lifetime. The insurance company calculates the amount of each income payment based on your purchase amount and your life expectancy.

A deferred annuity has two phases: the accumulation phase, during which you let your money grow, and the payout phase, during which you begin to receive scheduled payments. During accumulation, earnings grow tax-deferred until withdrawn. You decide when to take income from your annuity, and therefore, when to pay the taxes.

The payout phase begins when you withdraw income from your annuity and for most people this is during retirement. As your needs dictate, you can take partial withdrawals, completely surrender your annuity, or convert your annuity into a stream of income payments (known as annuitization). This last option is essentially the same as buying an immediate annuity.

Fixed, fixed index and variable annuities differ in the way they generate earnings and also in the amount of risk involved.

When you buy a fixed annuity, the insurance company guarantees you an interest rate for a certain period of time. At the end of this period, the insurance company will declare a renewal interest rate and another guarantee period. In addition, most fixed annuities have a minimum interest rate that is guaranteed for the life of the contract. In other words, regardless of market conditions, you will never receive less than your guaranteed percentage rate. Fixed annuities typically appeal to individuals who feel more comfortable knowing exactly how much their money is earning.

A fixed index annuity gives you more performance risk than a fixed annuity however more potential return. It has less performance risk than a variable annuity but also less potential return. It is also known as an equity indexed annuity, but the name is not appropriate as you are not actually invested in specific equity products.

As its name implies, a fixed index annuity is a type of fixed annuity in which the interest rate is determined in part by reference to an investment-based index such as the S&P 500 Composite Stock Price Index which is a collection of 500 stocks intended to represent a broad segment of the market. As interest is credited, the interest earnings are locked in to the account value and the account will not participate in any future market downturns. Because of this reference to an index, the annuity offers the ability to earn credited interest resulting from a rising financial market while at the same time providing the security and guarantees similar to those associated with traditional fixed annuities.

With a variable annuity, you have added control over your investment dollars. You allocate your funds among a variety of investment options with objectives ranging from aggressive to conservative; insurance companies call these sub-accounts. Your investment returns are tied to the performance of the underlying investments of the sub-accounts. As an investment in securities, the principal amount and investment earnings in a variable annuity are not guaranteed and will fluctuate with the performance of the underlying investments. They differ from fixed products because the policy owner bears investment risk and possible loss of principal. As these products are more complex and have associated with them more risk, the broker who sells this annuity must be licensed to sell securities.

Fixed, fixed index and variable annuities offer you a combination of compound interest and tax deferral. When your earnings are not subject to taxes each year, they compound faster. Faster growth of your money means more retirement income for you in the long run.

Growth potential

A fixed index annuity has the potential for higher interest earnings than a traditional fixed annuity with a guaranteed minimum interest crediting rate. There’s also no direct downside market risk to your money. Your principal is protected from market fluctuations.

Helps you sleep better

An annuity can help you save money on a tax-deferred basis and can guarantee you’ll receive income for life. So no matter how long you live, you won’t outlive your retirement income.

Fills in the gaps

Sometimes pensions, IRAs and Social Security don’t provide enough income for you to live the way you want during retirement. A fixed index annuity can help supplement your retirement income.

In our opinion, yes.

An annuity gives you the certainty of receiving an agreed-upon, monthly income for the rest of your life, and for the life of your spouse in the case of a joint-and-survivor annuity.

A fixed annuity pays a regular stream of income while you live. An immediate annuity is purchased with a lump sum and begins to generate income immediately. Annuities offer many payout options and each one is guaranteed by the insurance company. Generally, the longer you obligate the company to pay you benefits, the lower your monthly check. Each company determines its payout scale by estimating survival rates and the company’s expected earnings on investments.

A variable annuity provides an alternative should you seek an investment with the potentially higher return of equities or to be more involved with the investment decisions. The investment alternatives offered by variable annuities give you flexibility to tailor your portfolio to meet your particular needs. Since variable annuities are not guaranteed, you’re assuming a greater degree of risk as you could lose your principal however; your return is potentially higher than with a fixed annuity.

With a fixed annuity you’re buying the guarantee of a fixed income but you lose control of your capital. A fixed annuity offers a guaranteed rate of return.

You can withdraw money from either a fixed or variable annuity as long as you have not annuitized it. Once the annuity is annuitized, the company pays only an income and no withdrawals may be made. You basically exchange the annuity value for income stream that lasts, depending on the options you selected, from a fixed number of years up to the remainder of your life.

Generally speaking you write a personal check for an annuity, since you can’t swap securities or an investment account for an annuity. There are however, several important situations in which you can exchange your funds for one or more annuities through:

  • A rollover of assets in a rollover IRA, 401(k) or qualified employer plan
  • 1035* exchange of any form of deferred annuity, in full or in part.
  • 1035* exchange of the cash value of a life insurance policy

* Section 1035 of the Internal Revenue Code

If you’d like to discuss this further please fill out the form on the right to speak to a licensed Annuity Alliance specialist.

That depends on how much guaranteed income you want to receive, when you want to receive it, for how long and your risk tolerance. It also depends on other sources of guaranteed income, such as Social Security and a pension. Also, the allocation of retirement savings into annuities should be considered as both a risk management and resource allocation decision. Because of the guaranteed income aspects of the annuity you should consider an annuity as an important part your resource allocation decision.

If you’d like to discuss this further please fill out the form on the right to speak to a licensed Annuity Alliance specialist.

Typically, the premium deposits you use to purchase the annuity will come from your accumulated retirement savings, any deferred annuities you may own, and a lump sum received from a life event. Those life events might include an inheritance, proceeds from the sale of a home or business, or proceeds from a life insurance policy. Premium deposits may also come from interest-bearing accounts, particularly if the interest earned is part of the retirement income you are spending. They can also come from retirement plans, like a 401(k) or 403(b), although these plans may offer their own set of annuity options. In finding premiums to fund your annuity you should generally look for assets where you don’t have to realize a taxable gain in order to purchase. Generally that excludes assets with a capital gain, such as a portfolio of stocks or mutual funds.

However, there are several situations in which the gain is currently not taxed:

Deferred annuity (fixed or variable annuity): Even though they may have appreciated in value since first purchased they may be exchanged income tax-free to another annuity under Section 1035 of the Internal Revenue Code. Eventually taxes will be paid however they can be spread out with the annuity payments when you may be in a lower tax bracket.

Proceeds from downsizing your home: The value of your home may have appreciated in value however up to $500,000 of those gains may be excluded from taxation.

Inheritance: While you may be receiving appreciated assets, they receive a step up in basis at death so that unrealized capital appreciation is not taxed.

If you’d like to discuss this further please fill out the form on the right to speak to a licensed Annuity Alliance specialist.

Whether you’re buying an immediate annuity or converting a deferred annuity into income payments, your options are essentially the same. You can choose to receive payments monthly, quarterly, semiannually, or annually. You can select a specific period of time in which to receive payments. You can also choose an option that will guarantee income payments for as long as you live. Income can also be paid either:

  • “in advance” which means that income will be from the start date
  • “in arrears” which means that income will be paid a month, quarter, half-year or year after the start date

Or “on a chosen start date” which means you can choose to have your income paid on a certain date each month. The first payment must be paid within one month of the start date of the plan and is only available where income is paid monthly.

Under current federal law annuities receive special tax treatment. Income tax on annuities is deferred which means you are not taxed on the interest your money earns while it is within the annuity. When you buy an immediate annuity or “annuitize” a deferred annuity, a portion of each payment is considered earnings, and a portion is a tax-free return of your principal. Earnings are taxable as ordinary income when distributed or if withdrawn before you turn 59 ½, a tax of 10% may be levied. Once enough payments have been made and you recover your entire tax-free principal, each additional payment will be fully taxable. There are other ways you can access the accumulated value in your annuity. For example, instead of annuitizing, you may want to take withdrawals. In that case, distributions represent taxable earnings first. After all the earnings are distributed, tax-free return of principal remains.

If your annuity is inside an IRA, 401(k), or other qualified retirement plan, 100 percent of each payment will be subject to taxes (unless a distribution represents after-tax contributions into the plan). You should consult your tax advisor regarding your particular situation.

Annuity Alliance is not authorized to give tax advice so please talk to your own tax or legal advisor to discuss your individual situation. If you’d like to discuss this further with a licensed Annuity Alliance specialist please fill out the form on the right.

One of the biggest advantages that annuities have to offer is that they provide can guarantee income payments. Only an insurance company issued annuity can guarantee lifetime and beneficiary income payments.

Unlike other tax-deferred retirement accounts such as 401(k)s and IRAs, there is no annual contribution limit for a non-qualified annuity. That allows you to put away more money for retirement, and is particularly useful for those that are closest to retirement age and need to catch up.

All the money you pay into an annuity compounds year after year without a tax bill from Uncle Sam. That ability to keep every dollar working for you can be a big advantage over taxable investments.

When you cash out, you can choose to take a lump-sum payment from your annuity however most retirees prefer to set up guaranteed payments for a specific length of time, or for the rest of their life, providing a steady stream of income.

The annuity serves as a complement to other retirement income sources, such as Social Security and pension plans to enable you to maintain a certain standard of living.

Surrender charges: You’re likely to face a prohibitive surrender charge for pulling money out of an annuity within the first several years after buying it. Surrender charges generally decline annually until they get to zero. Note that some annuities come with even heftier surrender charges of up to 20% in the first year.

High annual fees: If you invest in a variable annuity you may encounter high annual expenses. You will have an annual insurance charge that can run 1.25% or more, annual investment management fees that range anywhere from 0.5% to more than 2% and fees for various insurance riders that can add another 0.6% or more. Add them up, and you could be paying 2% to 3% a year, if not more. That could take a huge bite out of your retirement nest egg, and in some cases even cancel out some of the benefits of an annuity.

Also, as with a 401(k) or IRA it’s generally not a good idea to take out any money from an annuity until you reach age 59 ½ because withdrawals made prior to that are hit with a 10% early withdrawal penalty.

Make sure to ask about the fees or costs attached to every annuity contract. Many companies do not charge an initial commission, or load, but instead levy a substantial surrender charge of your principal if you wish to cash out or transfer your annuity to another company within the first five or 10 years of the contract. Some annuities do permit a free withdrawal after the first year but then apply surrender charges for the subsequent years. This allows you to withdraw a certain portion (usually 10%) of the accumulated account value. Note that withdrawals are subject to income tax and prior to age 59 ½ withdrawals would be subject to a 10% penalty tax by the IRS. Annuity surrender charges do not apply to immediate annuities because once you have purchased the contract it cannot be surrendered. Variable annuities often have higher expenses than fixed annuities because of the various sub-accounts, often running up to 3% or more. In fact, many experts say that you need to own a variable deferred annuity for at least 15 years to make it a more worthwhile investment than doing so on your own with say, a mutual fund. That number is somewhat less for fixed annuities but it’s still something to consider. If you’re talking about immediate variable annuities, higher expenses mean lower monthly checks to you.
Most annuities allow withdrawals at least once a year (usually 10 to 15 percent of the accumulated value in your annuity) without a company withdrawal charge; however the income tax rules still apply to any withdrawal. Another way to receive income from your annuity is through a systematic withdrawal plan. A systematic withdrawal plan allows you to enjoy a steady stream of income on a monthly, quarterly, semiannual, or annual basis. Unlike annuitization which is a permanent decision, systematic withdrawals allow you to start or stop your income payments as your needs dictate. You also have the flexibility of increasing or decreasing your payments whenever you want. Systematic withdrawals give you added flexibility without giving up control of your money or your taxes. Systematic withdrawals tax your earnings first, so when all of your earnings have been exhausted, tax-free return of principal remains.
Annuities can only be sold by licensed insurance professionals who completed product specific training. The agent must be a representative of the insurance company and must hold a valid insurance license in your state. Agents and representatives are compensated by the insurance company. No sales compensation is ever deducted from your annuity principal.
There is a competitive market for annuities with hundreds of different companies offering them to the public. For the same type of annuity there might be a difference of as much as 5% to 10% in purchase rates. Making the right choice is critical as making the wrong choice could have a significant negative impact to your retirement funds.

Insurance company financial rankings may fluctuate based on company objectives and market conditions therefore you will want to get current rankings whenever considering a new purchase. Since there may be little difference in product features you generally want to select the company with the best rates. However you still want to pay attention to insurance company ratings which are assigned to insurance companies through recognized rating agencies.

The following situations are examples where an annuity might be exactly what you need.

You’re saving for retirement: If you’re already contributing the maximum to other retirement plans like an IRA or 401(k), a fixed indexed annuity is an attractive retirement planning option that grows tax-deferred.

You don’t need the money soon: If you don’t anticipate needing the money from a fixed indexed annuity prior to the time you turn 59½ then a fixed indexed annuity may be a good option for you.

You’re worried you might outlive your savings: Annuities can provide guaranteed income for the rest of your life, no matter whether you live to be 100 or even 120. With modern advances in health and medicine people are living longer than ever.

The transactions that follow your death depend on the type of annuity you owned and how your payouts were calculated. When you first purchased the annuity you had the option of naming a beneficiary on your account and with certain types of payout options, that beneficiary could receive the money in your annuity when you die. Other options just pay out during your lifetime and so the payments stop when you die. If you built in a spousal continuation benefit then your income payments pass on to your spouse.
There is a competitive market for annuities with hundreds of different companies offering them to the public. For the same type of annuity there might be a difference of as much as 5% to 10% in purchase rates. Making the right choice is critical as making the wrong choice could have a significant negative impact to your retirement funds.

Insurance company financial rankings may fluctuate based on company objectives and market conditions therefore you will want to get current rankings whenever considering a new purchase. Since there may be little difference in product features you generally want to select the company with the best rates. However you still want to pay attention to insurance company ratings which are assigned to insurance companies through recognized rating agencies.

Many states have laws that give you a set number of days to look at the annuity contract after you buy it. If you decide during that time you don’t want the annuity you can return the contract and get all your money back. This is often referred to as a free look period or right to return period. The free look period should be prominently stated in your contract. Be sure to read your contract during the free look period.
Qualified annuities have funds that comply with federal tax code requirements for retirement plans such as Traditional IRAs, Roth IRAs, SEP-IRAs, 403(b)s or TSAs, and are therefore eligible for certain tax advantages and treatments.

Non-qualified annuities have funds that come from an after tax source such as a savings account, the sale of a house, the sale of stocks/bonds, etc.

Qualified and non-qualified annuities each offer tax-deferred compounding and the option of guaranteed lifetime income. Each tax qualified annuity may be subject to tax penalties for withdrawals before age 59½. Consult a professional for specific tax-related advice.

If a joint and survivor annuity is purchased, a joint annuitant is the person named to continue receiving benefit payments upon the annuitant’s death. Depending on the type of annuity, the joint annuitant’s gender and age are also used to determine how long the benefits will be payable. After a purchase is made the joint annuitant cannot be changed, whereas the beneficiary can be changed. A beneficiary is a person named to receive a lump sum death benefit or monthly payments after the annuitant and/or joint annuitant’s death, if applicable.
The accumulation phase of an annuity is the time during which the value of the annuity is growing. This phase ends when the annuitization or payout phase begins (the day you start receiving payments).
Annuity riders have been around for decades, but became popular after the stock market crash in 2008. Investors were driven to find annuities that had income guarantees attached to their mutual fund investments. Those attached benefits are called income riders, and were originally used with variable annuities. Today, income riders are diverse and can be purchased on fixed indexed annuities as well.
While traditional life insurance guards against “dying too soon,” an annuity, in essence, can be used as insurance against “living too long.” With an annuity, you will receive in return a series of periodic payments that are guaranteed as to the amount and the payment period. Thus, if you choose to take the annuity payments over your lifetime (there are many other options), you will have a guaranteed source of “income” until your death.

If you “die too soon” (that is if you don’t outlive your life expectancy), your beneficiary will get back from the insurer far more than you paid in. On the other hand, if you “live too long” and outlive your life expectancy you may get back far more than the cost of your annuity.

Variable deferred annuities and variable immediate annuities are not considered liquid. Variable deferred annuities carry IRS penalties for early withdrawals and can have surrender charges assessed, while variable immediate annuities only offer fixed monthly payments and do not allow for the total lump sum to be liquidated.
Annuity Alliance has access to trained and qualified advisors across the U.S. who can educate you on the different types of annuity products and services to help you achieve your long-term retirement planning and income needs. To learn more about annuities, get rates or inquire about purchasing one please contact one of our licensed specialists for a free, no obligation consultation.

Intermediate Guide to Annuities

Learning more about annuities can help you understand what options are available to you. Below are the answers to questions that many investors similar to yourself, have asked our licensed annuity experts.

Then your assets will pass along to your contract’s named beneficiary. The beneficiary you named (you can have more than one beneficiary) will receive the death benefit you elected.
You can ask to surrender the annuity, however  you may have to pay a surrender charge. If you are younger than 59 ½, and have a tax qualified annuity, you will be hit with a 10% excise tax on your early withdrawal.

Alternatively, you can opt to transfer your money to another annuity in what is known as a 1035 exchange. The surrender charge, if any, still applies but you won’t incur any tax or tax penalty. But this method has some risks as you might have to pay another sales commission and your surrender clock may start all over again.

Two features that have the greatest effect to the amount of additional interest that may be credited to a fixed index annuity are the indexing method selected and the participation rate. It is important to understand these features and how they work together. The following are some other fixed index annuity features that affect the index-linked opportunity.

Indexing method

The indexing method means the approach used to measure the amount of change, if any, in the index. Some of the most common indexing methods, which are explained more fully later on, include annual reset (ratcheting), high-water mark and point-to-point.

Term

The index term is the period over which index-linked interest is calculated. The interest is credited to the annuity at the end of a term. Terms are generally from one to ten years, with six or seven years being most common. Some annuities offer single terms while others offer multiple, consecutive terms, there will usually be a window at the end of every term, typically 30 days, during which you may withdraw your money without penalty. For installment premium annuities, the payment of each premium may begin a new term for that premium.

Participation Rate

The participation rate decides how much of the increase in the index will be used to calculate the index-linked interest. For example, if the calculated change in the index is 10% and the participation rate is 70%, the index-linked interest rate for your annuity will be 7% (10% x 70% = 7%). A company may set a different participation rate for newly issued annuities as often as each day. Therefore, the initial participation rate in your annuity will depend on when it is issued by the company. The company usually guarantees the participation rate for a specific period (from one year to the entire term) and when that period is over the company sets a new participation rate. Some annuities guarantee that the participation rate will never be set lower than the specified minimum or higher than a specified maximum.

Cap Rate or Cap

Some annuities may put an upper limit or cap on the index-linked interest rate. This is the maximum rate of interest the annuity will earn. In the example given above, if the contract has a 6% cap rate, 6% and not 7% would be credited. Not all annuities have a cap rate.

Floor on Fixed Index-Linked interest

The floor is the minimum index-linked interest rate you will earn. The most common floor is 0%. A 0% floor assures that even if the index decreases in value the index-linked interest that you earn will be zero and not negative. As in the case of a cap not all annuities have a stated floor on index-linked interest rates. But in all cases your fixed annuity will have a minimum guaranteed value.

Averaging

In some annuities the average of an index’s value is used rather than the actual value of the index on a specific date. The index averaging may occur at the beginning, the end, or throughout the entire term of the annuity.

Interest Compounding

Some annuities pay simple interest during an index term. That means index-linked interest is added to your original premium but does not compound during the term. Others pay compound interest during a term which means that index-linked interest that has already been credited also earns interest in the future. In either case however, the interest earned in one term is usually compounded in the next.

Margin/Spread/Administrative Fee

In some annuities the index-linked interest rate is computed by subtracting a specific percentage from any calculated change in the index. This percentage sometimes referred to as the “margin”, “spread” or “administrative fee”, might be instead of, or in addition to, a participation rate. For example, if the calculated change in the index is 10%, your annuity might specify that 2.25% will be subtracted from the rate to determine the interest rate credited. In this example, the company subtracts the percentage only if the change in the index produces a positive interest rate.

Vesting

Some annuities credit none of the index-linked interest or only part of it, if you take out all your money before the end of the term. The percentage that is vested, or credited, generally increases as the term comes closer to its end and is always 100% at the end of the term.

Annual Reset

Index-linked interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the contract year. Interest is added to your annuity each year during the term.

High-Water Mark

The index-linked interest, if any, is determined by looking at the index value at various points during the term; usually the annual anniversaries of the date you bought the annuity. The interest is based on the difference between the highest index value and the index value at the start of the term. Interest is added to your annuity at the end of the term.

Low-Water Mark

The index-linked interest, if any, is determined by looking at the index value at various points during the term; usually the annual anniversaries of the date you bought the annuity. The interest is based on the difference between the index value at the end of the term and the lowest index value. Interest is added to your annuity at the end of the term.

Point to Point

The index-linked interest, if any is based on the difference between the index value at the end of the term and the index value at the start of the term. Interest is added to your annuity at the end of the term.

Annual Reset Feature: Since the interest earned is “locked in” annually and the index value is “reset” at the end of each year, future decreases in the index will not affect the interest you have already earned. Therefore your annuity using the annual reset method may credit more interest than annuities using other methods when the index fluctuates up and down often during the term. This design is more likely than others to give you access to index-linked interest before the term ends.

Annual Reset Trade Off: Your annuity’s participation rate may change each year and generally will be lower than that of other indexing methods. Also, an annual reset design may use a cap or averaging to limit the total amount of interest you might earn each year

High Water Mark Feature: Since interest is calculated using the highest value of the index on a contract anniversary during the term, this method may credit higher than some other methods if the index reaches a high point early in the middle of the term and then drops off at the end of the term.

High Water Mark Trade Off: Interest is not credited until the end of the term. In some annuities if you surrender your annuity before the end of the term you may not get index-linked interest for that term. In other annuities you may receive index-linked interest based on the highest anniversary value to date and the annuity’s vesting schedule. Also contracts with this design may have a lower participation rate than annuities using other designs or may use a cap to limit the total amount of interest you might earn.

Low Water Mark Feature: Since the interest is calculated using the lowest value of the index prior to the end of the term, this method may credit higher interest than some other methods if the index reaches a low point early or in the middle of the term and then rises at the end of the term.

Low Water Mark Trade Off: Interest is not credited until the end of the term. In some annuities if you surrender your annuity before the end of the term you may not get index-linked interest for that term. In other annuities you may receive index-linked interest based on a comparison of the lowest anniversary value to date with the index value at surrender and annuity’s vesting schedule. Also contracts with this design may have a lower participation rate than annuities using other designs or may use a cap to limit the total amount of interest you might earn.

Point-to-Point Feature: Since the interest cannot be calculated before the end of the term, use of this method may permit a higher participation rate than annuities using other designs.

Point-to-Point Trade Off: Interest is not credited until the end of the term, typically six or seven years. You may not be able to get the index-linked interest until the end of the term.

When an insurance company begins paying out the proceeds of an annuity, the annuity is said to be annuitizing. The process is called annuitization. A person should not annuitize their annuity without careful thought. Once an annuity is annuitized the annuitization cannot be reversed. Also, withdrawal of the funds within the annuity is no longer possible. Annuitization effectively exchanges the cash in the annuity for a guaranteed income stream and as a result, it is quite inflexible.
The guaranteed rate of an annuity is the rate defined in the contract. Typically this is the minimum rate the contract will pay you. The current rate is the rate, usually higher than the guaranteed rate, paid by the company when the company chooses to pay a higher rate. The current rate is not contractual and is established by the insurance company.
The floor refers to the minimum guaranteed amount credited to the account.
As you select a guaranteed income annuity, there are several factors that will affect the amount of income you’ll receive for a given amount of money.

Gender: All things being equal, income annuities generally provide higher payments to males which is one of the few benefits of having a lower life expectancy.

Age: The younger you are, the longer your life expectancy, and thus the lower your income.

Features: The greater your guarantees then the lower your income. For example, an annuity that guarantees income for a certain period of time will have a lower payout rate than one that stops as soon as you die.

Interest rates: If you purchase your annuity when rates are relatively high, you’ll receive more income than when rates are lower. One way to reduce the risk of buying at an inopportune time is to purchase multiple income annuities over a period of years.

No. It is important to know that not all income riders are the same.

They are unique to each issuing carrier, and sometimes unique to the specific product being offered. An income rider with one annuity company might be very different from an income rider from a competing annuity company.

It is important to fully understand the contractual guarantees and limitations of a rider, and you should shop numerous carriers to find the best guarantee. For instance, income rider or death benefit rider growth could be simple interest or compound interest. That small detail can make a very big difference down the road.

The majority of riders offered come with a premium cost, often for the life of the policy. That cost is typically deducted from the accumulation (investment) value on the contract anniversary date. The fee does not come out of the rider value, which is one of the key benefits of the rider strategy.
Credited interest on your annuities are not reported or taxed until the money is withdrawn. Once you begin to receive your retirement income, you will receive IRS Form 1099 for tax reporting purposes.
At first glance, the immediate annuity would seem to make sense for retirees with lump-sum distributions from retirement plans. After all, an initial lump-sum premium can be converted into a series of monthly, quarterly or yearly payments, representing a portion of principal plus interest, and guaranteed to last for life. The portion of the periodic payout that is a return of principal is excluded from taxable income.

However, there are risks. For one thing, when you lock yourself into a lifetime of level payments you aren’t guarding against inflation. You are also gambling that you will live long enough to get your money back. Thus, if you buy a $150,000 annuity and die after collecting only $60,000, and without planning or naming a beneficiary, the insurer often gets to keep the rest.

You can hedge your bets by opting for what’s called a “certain period,” which, in the event of your death, guarantees payment for a number of years to your beneficiaries. There are also “joint-and-survivor” options which pay your spouse for the remainder of his or her life after you die, or a “refund” feature, in which a portion of the remaining principal is given to your beneficiaries.

Some plans offer quasi-inflation adjusted payments. There are several companies that offer a guaranteed increase in payments of 10 percent at three-year intervals for the first 15 years. Payments are then subject to an annual cost-of-living adjustment with a 3 percent maximum. However, for these enhancements to apply you will have to settle for much lower monthly payments than the simple version.

A few companies have introduced immediate annuities that offer potentially higher returns in return for some market risk. These “variable, immediate annuities” convert an initial premium into a lifetime income; however, they tie the monthly payments to the returns on a basket of mutual funds.

If you want a comfortable retirement income, your best bet is a balanced portfolio of mutual funds. If you want to guarantee that you will not outlive your money, you can plan your withdrawals over a longer time horizon.

Age, your health, and expectations of longevity (yes, your genes do count) should be taken into consideration when purchasing a Retirement Income Annuity. In fact, many life insurance companies do not offer annuities to investors over age 80, or if they do, beneficiary protection is required.

Unlike life insurance policies, applications for annuities do not require any underwriting regarding your health. If your health and/or life expectancy is an issue, you may want to consider an annuity with beneficiary protection such as life with 100% refund, even if you are not yet age 80.

Before you buy an annuity, consider the following:

The money contributed to a non-qualified annuity may be in post-tax dollars. When you contribute after-tax savings to an annuity you can put in as much money as you like. Before you put after-tax savings into an annuity, it may be advisable for you to first put the maximum pre-tax amount into a qualified retirement plan such as your IRA, SEP, 401(k) or 403(b). Annuities can also fund these qualified retirement plans. When an annuity is used to fund these vehicles there are contribution limits that apply and federal tax laws generally require that you begin taking minimum distributions by April 1 of the calendar year following the year in which you reach age 70 ½. Failure to do so will result in a tax penalty of 50 percent of the amount of the shortfall. Additionally, once money is in your 401(k) or 403(b) plan you generally cannot make withdrawals before age 59 ½ except for special circumstances such as severance from employment, death or disability. If you meet an exception, withdrawals of taxable amounts are subject to ordinary income taxes and may be subject to a 10 percent federal tax penalty for pre-59 ½ withdrawals.

Expenses can vary. Make sure that the annuity contracts you consider have competitive costs. Independent rating services such as Morningstar and Lipper Analytical Services publish reports that compare variable annuity fees. While cheaper doesn’t necessarily mean better, if a contract is too expensive it could offset gains from the tax-deferred status.

All earnings from annuities are taxed as ordinary income when distributed. If your ordinary income tax rate at retirement is higher than the applicable long-term capital gains rate for certain investments you would actually pay higher taxes. You do, however, gain a tax deferral on earnings. With some other investments you could be subject to ordinary income taxes as well as capital gains taxes annually, even if you have not cashed in the investment, which can then reduce the value of your earnings.

If you’ve decided that an annuity makes sense for you, here are several key questions to ask yourself before signing up:

  1. Have you done some comparison shopping and considered all of your options? Because annuities are long-term savings vehicles you’ll want to make sure the company you pick will be around at least as long as you will. And, as you learned in the previous discussion, different annuities offer a wide range of choices, prices, features and flexibility.
  2. Does the rate on a fixed annuity look too good to be true? You want a competitive interest rate at renewal time. If the company is offering bonus rates (a higher interest rate for a set period of time) make sure the underlying interest rate is financially attractive and consider any additional contract costs or early surrender fees. Once the bonus rate term expires, you have no guarantee going forward that renewal rates will be competitive.
  3. What are the annuity’s surrender fees and how long are they in place? If the initial surrender fee is a high (typical fees are around 10 percent and decline over a period of approximately 5 to 7 years), you could find yourself locked into a contract from which it will be costly to escape.
  4. What is the track record of the funding options offered in a variable annuity? Don’t be swayed by last month’s top performer. Look for strong returns over a three-to-five-year period or more. Newspapers such as Barron’s and the Wall Street Journal publish rankings of various funding options on a regular basis. The history of various funding options also can be found in Morningstar and Lipper Analytical Services publications. Remember, past performance is not a guarantee of future results.
  5. Does a variable annuity offer multiple funding options in case you change your investment strategy a few years down the road? Look for a range of funds to diversify your retirement savings as your needs change.
  6. Will your ordinary income tax rate be greater than the applicable capital gains rate when you begin to take distributions (possibly at retirement)? If so, you may pay more in taxes by choosing annuities over another investment that would be taxed at the capital gains rate. Keep in mind, however, that your money in an annuity is accumulating on a tax-deferred basis. By selecting an annuity, you can avoid paying yearly ordinary income tax on the earnings while your money can compound and grow.
  7. What is the insurance company’s rating? While anyone who is properly licensed to sell insurance products (e.g., banks, brokers, agents) can sell annuities, the insurance company issues the annuity contract. So, you’ll want to consider the company’s rating when considering annuity product guarantees. Is it financially strong, with a good claims-paying record? While this is most important for fixed annuities, it is relevant to any guarantees (e.g., death benefit) in a variable annuity as well. Checking up on an insurance company is easy at your local library or on the Internet. You can also contact your state’s Department of Insurance. Annuity guarantees are based on the claims paying ability of the insurance carrier.
If you decide an annuity is appropriate for you, then please answer the following four questions to help narrow down your annuity options.

  1. How secure do you want the annuity to be? If you want the returns from an annuity to be at a guaranteed predetermined interest rate then a fixed annuity is ideal. If you want a return that varies with the success of the investments made for you by the insurance company then a variable annuity is ideal.
  2. How do you want to pay for the annuity? If you want to make a single, lump sum payment for my annuity then a single premium annuity would be better suited. If you’d rather make ongoing payments at regular intervals then a flexible payment annuity is what you’re looking for.
  3. When do you want to begin getting returns (payout) on your money? If you want to begin receiving the income from your annuity right away then an immediate annuity is ideal. If you want to begin receiving the income at a future date (e.g., at retirement) then you need to purchase a deferred annuity.
  4. How do you want your deferred proceeds to be paid out? If you want payments for the rest of your life then a straight life option is what you need. If you want payments for life and for the rest of your spouse’s life then you need a joint and survivor option. If you want payments for life but in the event you die prematurely would like the remaining money to go to your beneficiaries then a life annuity with a refund feature option would be ideal.
  • Is this a single premium or multiple premium contract?
  • Is this a fixed, fixed index or variable annuity?
  • What is the initial interest rate and how long is it guaranteed?
  • Does the initial rate include a bonus rate and how much is this bonus?
  • What is the guaranteed minimum interest rate?
  • What renewal rate is the company crediting on annuity contracts of the same type that were issued last year?
  • Are there withdrawal or surrender charges or penalties if I want to end my contract early and take out all my money? If so, how much are they?
  • Can I get a partial withdrawal without paying surrender or other charges or losing interest?
  • Does my annuity waive withdrawal charges for such reasons as death, confinement in a nursing home or terminal illness?
  • Is there a market value adjustment (MVA) provision in my annuity?
  • What other charges, if any, may be deducted from my premium or contract value?
  • If I pick a shorter or longer payout period or surrender the annuity, will the accumulated value or the way interest is credited change?
  • Is there a death benefit? How is it set? Can it change?
  • What income payment options can I choose? Once I choose a payment option, can I change it?
Annuity Alliance has access to trained and qualified advisors across the U.S. who can educate you on the different types of annuity products and services to help you achieve your long-term retirement planning and income needs. To learn more about annuities, get rates or inquire about purchasing one please contact one of our licensed specialists for a free, no obligation consultation.

Advanced Guide to Annuities

Learning more about annuities can help you understand what options are available to you. Below are the answers to questions that many investors similar to yourself, have asked our licensed annuity experts.

It depends on which type of annuity you have. If you choose a fixed-rate annuity then you’re not responsible for choosing the investments, the insurance company is and agrees to pay you a pre-determined fixed return.

When you opt for a variable annuity however, you decide how to invest your money in the sub-accounts (essentially mutual funds) offered within the annuity. The value of your account depends on the performance of the funds you choose. While a variable annuity has the benefit of tax-deferred growth, its annual expenses are likely to be much higher than the expenses on regular mutual funds so ordinary funds may be a better option. Please check with a financial professional and if you would like to talk to an Annuity Alliance professional to get free, expert advice on your unique situation please fill out the form.

While insurance companies may have different longevity experience within their pool of annuitants, they all make assumptions that the individuals electing to purchase an annuity are in good health. Therefore, if you’re in poor health or believe that you have a shorter life expectancy for genetic reasons, a life annuity may be the wrong purchase for you. If you want the peace of mind coming from guaranteed retirement income then you can elect a fixed period annuity for 5, 10 or 20 years.

If you and your spouse are considering a joint and survivor annuity and one of you is in poor health, you may want to consider combining a life annuity on the healthy spouse and a certain (fixed period) annuity on the one in poor health.

If you’d like to discuss this further please fill out the form on the right to speak to a licensed Annuity Alliance specialist.

Read all the sales documents yourself and make sure you are aware of every potential fee. Listen to your salesperson’s explanation however do not rely on it alone.

Be cautious if anyone suggests you exchange your existing annuity for a new annuity. Annuity exchanges are known as 1035 exchanges after the section of the IRS code that regulates them. A salesperson may tell you a 1035 swap is a great deal because it allows you to get the features of a new annuity without incurring any taxes.

But by moving into a new annuity you will likely start a new surrender period. For example, say you have owned an annuity for 10 years; you probably could close out your account without paying a surrender charge. But if you swap that annuity for a new one you will now have a new surrender charge period that can last 10 years or so.

Most 401(k) plans offer a series of annuity options but little help in assisting you make the right decision. They do require that if you elect an annuity option you elect out of a joint and survivor annuity. Under this annuity the annuity payments will continue to your spouse; either at the same amount or another amount you select.

When considering an annuity option offered through your employer you should also shop the commercial annuity market. There may be better rates and different options to choose from.

Maybe, since one of the main advantages of an annuity is that your money grows tax-deferred. However, under current tax rules, you will need to begin income by April 1st of the year following the year you turn age 70 & ½. If you’re retired or very close to retiring and you feel you need more guaranteed income than social security will provide, it can make sense to use a portion of your 401(k) or IRA money to buy an immediate annuity that will pay income for life. Also, if you are looking for the safety and predictability that you’ll find in a fixed annuity it makes sense as well.
Your annuity beneficiaries will owe income tax on the gains that you deferred during your lifetime. This can be an advantage to them if they are taxed at a lower rate than you.

An annuity may be subject to estate taxes as well. An estate planning attorney can help you determine if estate taxes should factor into your decision to purchase an annuity.

Once an annuity is annuitized (you start taking regular income payments), there are no other options. The income is distributed as the contract requires, but there is no flexibility to increase or decrease the payments or to make cash withdrawals from the principal.
No. An income rider is an attached benefit that you can add to some deferred annuity policies that solves for a specific need like income, legacy, or confinement care. Income riders have to be chosen at the time of the application and cannot be added to the policy after the annuity has been issued.
Most income riders and death benefit riders offer a guaranteed annual growth amount that can be used only for a specific need. For example, an income rider might offer a contractual growth amount of 6% compounded annually for as long as you defer or for a specific period of time. That 6% compound growth amount can only be used for income and the high percentage stops accumulating as soon as you turn on the lifetime income stream. You can’t transfer the amount or peel off the 6% compound interest like you could with a CD, but you can use that amount for income.

Riders are typically separate calculations within the annuity contract used to determine payment levels.

For example, if an income rider is attached to a deferred annuity, your policy statement will show the accumulation (investment) value, surrender value, and the rider value. All three calculations are different.

There is generally a cost for annuity policy riders.

Some annuities provide income payments that increase each year by changes in the cost of living, usually subject to a maximum in any given year. For the equivalent premium and type of annuity, you start receiving lower payments. It will take a number of years for these increasing payments to begin to exceed the level payments you would have otherwise received from an annuity offering no such cost of living increases.

There are also annuities that increase the income payments by a fixed percentage, such as 2% each year.

If you’d like to discuss this further please fill out the form on the right to speak to a licensed Annuity Alliance specialist.

Yes, if the annuity is still in the accumulation phase. The IRS allows a few different ways for you to transfer your money from one annuity to another without paying taxes. Remember, that although the IRS allows tax-free transfers, your current company may charge surrender fees. You should always check your contract before transferring from one annuity to another.

SPDAs are designed to accumulate your savings on a tax deferred basis. These contracts can be converted into a stream of guaranteed income whenever you choose to do so.

Insurance and tax laws do not require that you make an exchange with the insurance company that issued your SPDA; therefore, you can and should get competitive quotes from other insurance companies offering retirement income. (No such thing as a RIA…just annuities that can provide retirement income)

Several benefits of exchanging your SPDA to income are:

  1. Obtaining secure lifetime income
  2. Excluding a portion of each payment from tax
  3. Locking in long term interest rates

Exchanging an existing SPDA may also impact other factors such as liquidity so exchanges should be done with considerable thought.

If you’d like to discuss this further please fill out the form on the right to speak to a licensed Annuity Alliance specialist.

Taxes may apply to your beneficiary (the person you designate to take further payments) or your heirs (your estate or those who take through the estate if you didn’t designate a beneficiary).

Income tax: Annuity payments collected by your beneficiaries or heirs may be subject to tax on the same principles that would apply to payments collected by you.

Exception: There’s no 10 percent penalty on withdrawal under age 59-1/2 regardless of the recipient’s age, or your age at death.

Estate tax: The present value at your death of the remaining annuity payments is an asset of your estate and subject to estate tax with other estate assets. Annuities passing to your surviving spouse or to charity would escape this tax.

Tax tables are set into law by the United States Congress and administered by the IRS. Each year, the new tables are posted on the IRS website in IRS Publication 151 and Notice 1036. Insurance companies who hold your annuity can update your Federal income tax withholding based on the new monthly periodic tax tables and formulas. They withhold the required federal taxes according to your marital status and exemptions (dependents) elected. You can change your tax withholding amount at any time. It is a good idea to check the amount of your Federal and State tax withholding each year.
Distribution options will vary depending on whether or not you are the surviving spouse or someone other than the surviving spouse. If you are the surviving spouse then you have several options but the most common action is to treat the annuity as your own, keeping all the options the owner had intact.

As someone other than the surviving spouse, you’ll basically have three potential options:

  1. Lump-sum payout
  2. Full payout over the next five years
  3. Elect within 60 days to annuitize over your own lifetime

If the annuity payments have already begun then you must take the payments at least as rapidly as the original owner was taking them.

When a person inherits an annuity the gains stay with the policy. Depending on the type of annuity, taxes will have to be paid on the lump sum received or on the regular fixed payments. The payments received from an annuity are treated as ordinary income which could have as high as 35% tax depending on your tax bracket.

Supposing that this annuity was purchased with after-tax dollars, ordinary income is owed on all gains, but not on the principal. A portion of each annuity payment will be considered a tax-free return of principal, spreading the tax liability out over time, unless you select the lump-sum payout.

The future value of an annuity is simply the future value of all your contributions based on the fixed rate of interest your investment accrues each year. If you know how much you plan to invest each year and the fixed rate of return your annuity guarantees, you can easily determine the value of your account at any point in the future.

The formula for the future value of an annuity assumes an ordinary annuity, meaning payments are made at the end of each period and all your payments are of equal value.

FV = P * {(((1+R)^N) – 1) / R}

In which P is the payment amount, R is the rate of interest and N is the number of periods.

The Time Value of Money

The future value calculation is based on the concept of the time value of money. This simply means a dollar earned today is worth more than a dollar earned tomorrow because funds you control now can be invested and earn interest over time. Therefore, the future value of an annuity is greater than the sum of all your investments because those contributions have been earning interest over time. For example, the future value of $1,000 invested today at 10% interest is $1,100 one year from now. A single dollar today is worth $1.10 in a year because of the time value of money.

Example

Assume you make annual payments of $5,000 to your annuity for 15 years. You have an ordinary annuity that earns 9% interest compounded annually:

FV = $5,000 * {(((1 + 0.09)^15) – 1) / 0.09}

= $5,000 * {((1.09^15) – 1) / 0.09}

= $5,000 * 2.642 / 0.09

= $5,000 * $146,804.58

Without the power of interest compounding, your series of $5,000 contributions is only worth $75,000 at the end of 15 years. Instead, with compounded interest, the future value of your annuity is almost twice that at $146,804.58.

Annuity Due

Unlike an ordinary annuity, an annuity due makes payments at the beginning of each period. To calculate the future value of an annuity due, simple multiply the ordinary future value by 1+R.

In the above example, the future value of annuity due with the same parameters is simply $146,804.58 * (1+0.09), or $160,016.99.

Annuity Alliance has access to trained and qualified advisors across the U.S. who can educate you on the different types of annuity products and services to help you achieve your long-term retirement planning and income needs. To learn more about annuities, get rates or inquire about purchasing one please contact one of our licensed specialists for a free, no obligation consultation.