Are you brand new to annuities? Then this BEGINNER section is dedicated to you. Please click on the question below to view the answers to the Frequently Asked Questions (FAQ). For more information, click the button below and complete the form to receive your free report from Annuity Alliance.

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 consumers, 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 is 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 the 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 an 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 contact us 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. The allocation of retirement savings into annuities also 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 of your resource allocation decision.

If you’d like to discuss this further, please contact us 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 also may come from interest-bearing accounts, particularly if the interest earned is part of the retirement income you are spending. They also can come from retirement plans, like a 401(k) or 403(b), although these plans may offer their 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 contact us 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, semi-annually, or annually. You can select a specific period of time in which to receive payments. You also can 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 59½, 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, the 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 contact us.

One of the biggest advantages that annuities have to offer is they can provide 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.

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 59½, 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 ten 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 59½, 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 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, semi-annual, 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, the 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 on 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 also are 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 agents across the United States 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.