Are you a little familiar with annuities? Then this INTERMEDIATE 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 annuity report.

Intermediate'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.

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 59½, 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 on 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.


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 10 years, with six or seven years being most common. Some annuities offer single terms while others offer multiple, consecutive terms. There usually will 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 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.

The 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 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.


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.


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. An annual reset design also 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. Contracts with this design also 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. Contracts with this design also 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, the 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. Withdrawal of the funds within the annuity also 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, several factors 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 an 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 is 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 also are 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. Several companies offer a guaranteed increase in payments of 10 percent at three-year intervals for the first 15 years. Payments then are 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 a 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 also can fund these qualified retirement plans. When an annuity is used to fund these vehicles, contribution limits 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 70½. Failure to do so will result in a tax penalty of 50 percent of the amount of the shortfall. Additionally, once the money is in your 401(k) or 403(b) plan, you generally cannot make withdrawals before age 59½ 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-59½ withdrawals.

Expenses can vary. Make sure 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. 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 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 also can 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 pre-determined 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 your 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 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.