Annuity Basics
- Start
- What are the different kinds of annuities?
- single or flexible premium?
- Immediate and Deffered Annuities?
- fixed and variable annuities?
- interest for fixed deferred annuity?
- What's Current interest rate?
- minimum guaranteed rate?
- multiple interest rates?
- charges or fees: fixed deferred annuity?
- fixed deferred annuity contract benefits?
- value depending on choice of benefit?
- tax treatment of annuities?
- What is a 'free look' period?
- fixed deferred annuity is right for me?
- What questions should I ask my agent?
What is an annuity?
An annuity is a contract in which an insurance company makes a series of income payments at regular intervals, in return for premiums you have paid.
Annuities are most often bought for future retirement income, because only an annuity can pay an income that can be guaranteed to last as long as you live.
An annuity is neither a life insurance nor a health insurance policy. It is not a savings account or a savings certificate.
What are the different kinds of annuities?
This guide explains major differences in different kinds of annuities to help you understand how each might meet your needs. But look at the specific terms of an individual contract that you are considering and the disclosure document you receive. If your annuity is being used to fund or provide benefits under a pension plan, the benefits you get will depend on the terms of the plan.
What are the differences between immediate and deferred annuities?
With an immediate annuity, income payments start no later than one year after you pay the premium. You usually pay for an immediate annuity with one payment.
The income payments from a deferred annuity often start many years later. A deferred annuity has two parts or periods. During the first period - the accumulation period - the money you put into the annuity, less any applicable charges, earns interest. The earnings grow tax deferred as long as you leave them in the annuity. In some annuity contracts there is a second period, called the payout period, the company pays income to you or to someone you choose.
What are the differences between fixed and variable annuities?
Fixed
During the accumulation period of a fixed deferred annuity, your money earns interest at rates set by the insurance company or in a way spelled out in the annuity contract. The company guarantees that it will pay no less than a minimum rate of interest. During the payout period, the amount of each income payment to you is generally set when the payments start and will not change.
Variable
During the accumulation period of a variable annuity, the insurance company puts your premiums into a separate account. You decide how the company will invest those premiums, depending on how much risk you want to take. You may put your premium into a stock, bond, or other account, with no guarantees, or into a fixed account, with a minimum guaranteed interest. During the payout period, the amount of each income payment to you may be fixed (set at the beginning) or variable (changing the value of the investments in the separate account).
How are interest rates set for my fixed deferred annuity?
During the accumulation period, your money earns interest at rates that change. Usually, what these rates will be is up to the insurance company. There are MYGA (Multi Year Guarantee Annuities) which will not change for the suggested term of the contract.
What is a current interest rate?
The current rate is the rate the company decides to credit to your contract at a particular time, which the company guarantees will not change for some period.
The initial rate is an interest rate the insurance company may credit for a set period of time after you first buy your annuity. The initial rate in some contracts may be higher than it will be later. This is often called a bonus rate.
The renewal rate is the rate credited by the company after the end of the set time period. The contract tells how the company will set the renewal rate, which may be tied to an external reference or index.
What is a minimum guaranteed rate?
The minimum guaranteed interest rate is the lowest rate your annuity will earn. This rate is stated in the contract.
What are multiple interest rates?
Some annuity contacts apply different interest rates to each premium you pay or to premiums you pay during different time periods. Other annuity contracts may have two or more accumulated values that fund different benefit options, and these accumulated values may use different interest rates. You get only one of the accumulated values depending on which benefit you choose.
What charges or fees may be subtracted from my fixed deferred annuity?
Most annuities have charges related to the cost of selling or servicing it. These charges may be subtracted directly from the contract value. Ask your agent or the company to describe the charges that apply to your annuity, if any.
Surrender of withdrawal charges
If you need access to your money, you may be able to take all or part of the value out of your annuity at any time during the accumulation period. If you take out part of the value, you may pay a withdrawal charge. If you take out all of the value and surrender, or terminate, the annuity, you may pay a surrender charge. In either case, the company will figure the charge as a set percentage of the value of the contract, of the premiums you have paid or of the amount you are withdrawing. The company may reduce or even eliminate the surrender charge after you've had the contract for a stated number of years (term). A company may also waive the surrender charge when it pays a death benefit.
Some annuities have stated terms. When the term is up, the contract may automatically expire or renew. You are usually given a short period of time, called a window, to decide if you want to renew or surrender the annuity. If you surrender during the window, you won't have to pay surrender charges, but if you renew, the surrender or withdrawal charges may start over.
For some annuities, there is no charge if you surrender your contract when the company's current interest rate falls below a certain level. This is sometimes called a bail out option.
In a flexible premium annuity, the surrender charge may apply to each premium paid for a certain period of time. This may be called a rolling surrender or withdrawal charge. Some annuity contracts have a market value adjustment feature. If interest rates are different when you surrender your annuity than when you bought it, a market value adjustment (MVA) may make the cash surrender value higher or lower. Since you and the insurance company share this risk, an annuity with an MVA feature may credit a higher rate than an annuity without that feature.
Free withdrawal
Your annuity may have a limited free withdrawal feature. That lets you make one or more withdrawals without a charge. The size of the free withdrawal is often limited to a set percentage of your annuity contract value. If you make a larger withdrawal, you may pay withdrawal charges. You may lose any interest above the minimum guaranteed rate on the amount withdrawn.
Some annuities waive withdrawal charges in certain situations, such as death, confinement in a nursing home or terminal illness.
Contract fee
A contract fee is a flat dollar amount charged either once or annually.
Transaction fee
A transaction fee is a charge per premium payment or other transaction.
Percentage of premium charge
A percentage of premium charge is a charge determined from each premium paid. The percentage may be lower after the contract has been in force for a certain number of years, or after total premiums paid have reached a certain amount.
Premium tax
Some states charge a tax on annuities. The insurance company pays this tax to the state. The company may subtract the amount of the tax when you pay the premium, when you withdraw your contract value, when you start to receive income payments or when it pays a death benefit to your beneficiary.
What are some fixed deferred annuity contract benefits?
Annuity income payments
One of the most important benefits of deferred annuities is your ability to use the value built up during the accumulation period to give you a lump sum payment or to make income payments during the payout period. Income payments are usually made monthly but you may choose to receive them less often. The size of the income payments is based on the accumulated value in your annuity and the benefit rate which is in effect when payments start.
The benefit rate usually depends on your age, sex, and the annuity payment option you choose, if it is a lifetime payout. For example, you might choose payments that continue as long as you live, as long as your spouse lives, or only for a set number of years. There is a table of guaranteed benefit rates in each annuity contract.
Most companies have current benefit rates as well. The company can change the current rate at any time, but it can never be less than the guaranteed benefit rates.
When income payments start, the insurance company uses the benefit rate in effect at that time to figure the amount of your income payment. Companies may offer various income payment options, and you, or another person of your choice, may choose the option.
Life only
The company pays income for your lifetime, but doesn't make any payments to anyone after you die. You might choose this option if you have no dependents, if you have taken care of them through other means or if the dependents have enough income of their own. This payment option usually pays the highest income possible.
Life annuity with period certain
The company pays income for as long as you live and guarantees to make payments for a set number of years - called the period certain - even if you die. The period certain is usually 10 or 20 years. If you live longer than the period certain, you will still continue to receive payments until you die. However, if you die during the period certain, your beneficiary gets regular payments for the rest of that period. If you die after the period certain, your beneficiary does not receive any payments from your annuity. Each income payment will be smaller than in a life-only income option, because the period certain is an added benefit.
Joint and survivor
The company pays income as long as either you or your beneficiary lives. You may choose to decrease the amount of the payments after your death, or you may be able to choose to have payments continue for only a set length of time. Again, because the survivor feature is an added benefit, each income payment is smaller than in a life-only income option.
Death benefit
In some annuity contracts, the company may pay a death benefit to your beneficiary if you die before the income payments start. The most common death benefit is the contract value or the premiums paid, whichever is more.
Can my annuity's value be different depending on my choice of benefit?
While all deferred annuities offer a choice of benefits, some use different accumulated values to pay.
For example, an annuity may use one value if annuity payments are for retirement benefits and a different value if the annuity is surrendered. Or, an annuity may use one value for long-term care benefits and a different value if the annuity is surrendered.
You can't receive more than one benefit at the same time.
What is the tax treatment of annuities?
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 stays in the annuity. Tax-deferred accumulation is not the same as tax-free accumulation. An advantage of tax deferral is the tax bracket you are in when you receive annuity income payments may be lower than the one you are in during the accumulation period. You will also be earning interest on the amount you would have paid in taxes during the accumulation period.
Most states' tax laws on annuities follow the federal law. Part of the payments you receive from an annuity will be considered as a return of the premium you have paid. You won't have to pay taxes on that part. Another part of the payments is considered interest you have earned. You must pay taxes on the part that is considered interest when you withdraw the money. You may also have to pay a 10% tax penalty if you withdraw the accumulation before 59 ½. The Internal Revenue Code also has rules about the distributions after the death of a contract holder.
What is a "free look" period?
Many states have laws which give you a set number of days to look at the annuity contract after you buy it. If you decide during that time that 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 or right to return period. The free look period should be prominently stated in your contract. Be sure to read your contract carefully during the free look period.
How do I know if a fixed deferred annuity is right for me?
You should think about your goals for the money you put into the annuity, and how much risk you're willing to take.
Ask yourself the following questions.
- How much retirement income will I need in addition to what I'll get from Social Security and my pension?
- Will I need that additional income only for myself, or for myself and someone else?
- How long can I leave my money in the annuity?
- When will I need income payments?
- Does the annuity allow me to get money when I need it?
- Do I want a fixed annuity with a guaranteed interest rate and little or no risk of losing the principal?
- Do I want a variable annuity with the potential for higher earnings that aren't guaranteed and the possibility of losing principal?
What questions should I ask my agent or the company?
- Is this a single premium or flexible premium contract?
- Is this a Fixed-Indexed 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 the 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 withdrawals or surrender charges or penalties if I want to end my contract early and take out all of my money, and if so, how much are they?
- Can I get a partial withdrawal without paying surrender charges for reasons such 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 one payment option, can it be changed?
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