Dollars and Sense
Chapter 6
An annuity is a contract between the insured and an insurance company. A lump-sum payment or series of payments is made to the annuity. In return, the insurer agrees to make periodic payments to the insured beginning immediately or at some future date. Annuities offer tax-deferred growth of earnings and do not affect current taxation status unless funds are withdrawn. If a beneficiary is listed, upon the annuitant’s death proceeds go directly to the individuals or entities listed, bypassing probate procedures. Payout options vary so it is very important to understand which payout option has been selected since some payout options eliminate beneficiary designations.
There are generally two types of annuities—fixed and variable. In a fixed annuity, the insurance company guarantees the annuitant a minimum rate of interest during the time the account is growing and periodic payments will be a guaranteed amount per dollar resting in the account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as the annuitant’s lifetime or the lifetime of two or more named people.
Annuity Choices
Traditional annuities offer several choices. The combination of choices made
will affect the amount of funding available from the annuity at retirement. These
choices include:
Joint and Survivorship Annuities
Under joint and survivorship annuities the income is paid until the last policy annuitant dies. Although the annuitants are typically a husband and wife, it does not necessarily have to be this relationship. It could be a parent and child, sisters or brothers, business partners or any number of relationships. There may also be more than two people listed as payees. Joint and Survivorship annuities are often used with married couples because retirement is a joint issue. Even though each partner may have saved separately when building up his or her capital anything that was jointly earned and saved is typically paid to both parties in retirement.
A joint and survivorship annuity can be an option with any traditional
annuity. In many cases, it is also possible to select the level of income the
surviving spouse will receive. These decisions determine how much income is
received while both parties are alive. Most professionals feel the surviving
partner’s annuity should not drop below two-thirds of the joint annuity. It is
generally estimated that the difference between supporting one person and two
people is about one-third since many household costs are fixed, such as mortgages,
home insurance, gasoline, and utilities.
Guaranteed and Life-time-Certain Annuities
The guaranteed and life-time certain annuity is guaranteed for a predetermined number of years, whether the annuitant lives for the guaranteed period or not. If the annuitant dies before the guaranteed time period ends (often 10 years, but it can be much longer), the annuity continues to be paid to the person designated as beneficiary in the policy for the remainder of the guaranteed time period. Beneficiaries would not receive life time income; only the annuitant would receive income for their life time.
If the annuitant lives beyond the guaranteed income period, the income
continues to the annuitant only. If the annuitant dies beyond the guaranteed
period, any residue capital reverts to the life insurance company;
beneficiaries receive nothing. Only during the guaranteed period will
beneficiaries receive any income.
Level Annuities
Under level annuities, the annuitant receives the same amount of income each and every month for the period of the annuity. Inflation can reduce the buying power of the income since the amount the annuitant receives each month never changes. Once the annuity is annuitized the income begins, but it is never adjusted for inflation or cost-of-living increases.
When the annuitant first begins receiving the annuity income, it will be
comparably higher than what might be drawn from another annuity types. However,
within a few years, due to inflation, it could be significantly less than what
would have been received if another annuity type had been chosen. The drawing
point is longevity since it pays to the end of the annuitant’s life,
potentially paying out far more than he or she actually saved or would have
earned in interest elsewhere. Therefore, it may be wise to use this type of
annuity but have other types of assets as well that make up for lost value
resulting from inflation and rising costs of living.
Capital-Back Guaranteed Annuities
Capital-back guaranteed annuities have two parts: an annuity and a life insurance policy. The annuity provides the annuitant with income and pays the premiums on the life insurance policy. This allows the annuitant to fully use the funds from the annuity for their lifetime, but still provides something for beneficiaries.
There may be double commissions if a commission is paid for the annuity and
another for the life insurance policy. Usually, it is possible to find such an
arrangement with a single commission rather than two. While the agent is not
likely to worry about double-paid commissions, consumers may prefer the lower
commission base of a single commission payment.
Escalating Annuities
The escalating annuity increases at a predetermined fixed amount each year. The annuity may track, lead or lag inflation, depending upon its structure. With these annuities, the annuitant receives less initially compared with a level rate annuity, but the increases in annuity income will help maintain the same standard of living for the duration of the annuity. It is designed to battle lost purchasing power due to inflation.
Most life companies will permit increases of no more than 20 percent each
year on an annuity with a 10-year income guarantee. Increases of 15 percent per
year may be permitted on a life annuity. It takes about nine years for an
annuity linked to an inflation rate of 10 percent to catch up with a level
annuity. Most professionals feel this is not too bad considering how long
people are now living.
Inflation-Linked Annuities
Inflation-linked annuities are linked directly to the inflation rate, increasing annually in line with the rate of inflation. Where escalating annuities have predetermined increases in income, this annuity actually tracks the rate of inflation.
Enhanced Annuities
These annuities are offered by a few life insurance companies to people who can prove they are in poor health. While this concept goes against what insurance companies normally do, it actually makes sense for the insurer. If the annuitant is likely to die soon or has bad habits such as smoking heavily, the life insurance company is less likely to pay out benefits for a long period of time. While no one can say positively how long or short their life may be, there are factors that are strong indicators of longevity. The details of these policies vary so it is very important to see what the annuitant is gaining by purchasing such a policy.
Annuity History
It would be easy to assume the annuity is a modern-day financial device, but they have been around for a very long time in one form or another. During the 1800s annuities even played a big role in Native Americans losing their lands to the US Government. During this period the government enticed the Indians into trading their vast lands for trinkets and guaranteed annuities, often at rates that constituted gross underpayment. The tribes were forced into smaller areas, where their only real income was from government annuities. When the Native Americans needed additional money to purchase food and clothing, they could only buy from certain Government-approved traders, who would extend credit to the Indians. As the Indians' debts to these traders increased, the tribes were forced to sell more land to cover their loans. In one instance, the Governor of Indiana, which was then a territory, settled seven treaties in four years with First Nations in southern Indiana, Wisconsin, Missouri, and Illinois. The natives sold their land for what amounted to two cents an acre (in some cases less), paid to them in guaranteed annuities. Historians generally agree that the First Nations, in this and many other cases, were deceived in selling at this price.[1]
Land treaties signed by the First Nations are, technically speaking, legitimate legal documents. They received goods, annuities, or a sum of money in return for a parcel of land. Of course, these “legitimate” (though certainly not fair) exchanges left many native people upset and confused, as they had never truly understood what they were selling. The tribes did not understand the transactions since they did not live by or use the concept of property ownership. They were likely unaware that they would no longer be able to use the land after they sold it. To make matters worse, the treaties were often negotiated under duress. Native leaders were bribed and softened up with alcohol, and when that didn't work, threats were often made to stop payments on annuities from past treaties. Whenever these strategies failed, the US government was also not averse to sanctioning militant efforts to force the Native Americans off their lands.
As time went on, a number of Native American tribes became increasingly dependent on annuity payments and so were compelled to sell more and more land to the federal government. In a span of fourteen years the Potawatomi tribe, for example, signed six land treaties, which resulted in the tribe giving up large swaths of land in Illinois, Michigan, Wisconsin, and Indiana. Instead of turning against the government, this tribe from the Chicago area became so reliant on annuities that they would do anything to protect their flow of payments. This included acting as peacemakers on behalf of the government in 1827 when their kindred Winnebago tribe from southern Wisconsin threatened to rise up against white settlers.
Annuities have been used in many ways. In the United States, all railroad employees and their families are entitled to a number of benefits under the Railroad Retirement Act and the Railroad Unemployment Insurance Act. These include unemployment insurance as well as retirement-survivor benefits, the latter of which is paid through an annuity that is administered by the Railroad Retirement Board (RRB), an independent agency of the US Government.
Like traditional insurance companies, the RRB has field representatives to help railroad workers and their families file claims for benefits. There are adjusters who determine the validity of the claims. Calculation of benefits and processing of payments is highly automated, and the RRB also employs information technology staff to manage the various electronic systems.
The Great Depression brought about the RRB to a great extent. The railroads were ahead of other industries in introducing private pension plans. The first American railroad pension plan dates back to 1874. During the 1930s, however, serious defects in early private pension plans became magnified by the Depression, and a more suitable solution had to be found. Legislation was passed, creating a national retirement benefit annuity program for railroad staff.
The Depression highlighted how many elderly citizens had either insufficient retirement income or none at all. It was the Great Depression that gave birth to the idea of Social Security, although it did not become a reality until 1935. Railroad workers saw an immediate need for retirement benefits during the early thirties. Rather than stand around waiting for the government to offer a solution, they expanded upon and unified the existing private plans under one umbrella.
Beginning in 1934 the entire RRB system was implemented by 1937. Social Security was a reality by now, but the RRB began delivering benefits before Social Security did. The railroad retirement system still remains separate from Social Security, although the two are closely linked. A retiring railroad worker is entitled to a railroad annuity that is greater than the amount he or she would receive from Social Security. The portion corresponding to that which he or she would receive from Social Security is partially reinsured by the Social Security system. In this way, the funds are in the same position they would be in if the worker were covered by Social Security instead of the railroad program.
At one time employers wanted to provide retirement benefits to workers but this has gradually changed as costs became burdensome. Group annuities have been offered as a way to ensure the financial comfort of employees following retirement. Group annuities differ slightly from individual annuities in that the payout of a group annuity is dependent upon the life expectancy of all members of the group rather than on the individual. The administration costs of group annuity programs are usually absorbed by the employer.
Our annuity history includes use by our military. Not only were soldiers granted annuities, but their widows were often entitled to receive annuities as well. Widow’s claims exist in the form of letters sent and received between their representative and the government office responsible for issuing them.
Annuities existed on both state and national levels. In some cases, annuities were even awarded to women that served an important personal role in military campaigns. The Annuity Museum[2] has a newspaper article discussing the granting of an annuity to Molly Macauley. She participated beside her husband on the battle field during the Revolutionary War. Military annuities were awarded for bravery and service and protected the survivors of fallen American soldiers.
Annuities have been around for over two thousand years in one form or another. In Roman times, speculators sold financial instruments called annua, or annual stipends. In return for a lump sum payment, these contracts promised to pay the buyers a fixed yearly payment for life, or a specified period of time. The Roman Domitius Ulpianus was one of the first annuity dealers and is credited with creating the first life expectancy table.
During the Middle Ages lifetime annuities purchased with a single premium became a popular method of funding the nearly constant wars that characterized that period. There are records of a form of annuity called a tontine. This was an annuity pool in which participants purchased a share and received a life annuity in return. As participants died off, each survivor received a larger payment, until finally the last survivor received the remaining principal. Similar to our modern-day lottery, the tontine offered not only financial security but also a chance to win a jackpot.
During the 18th century, many European governments sold annuities providing lifetime income, which was guaranteed by the state. In England, Parliament enacted hundreds of laws regulating the sale of annuities to fund wars, provide a stipend to the royal family, and to reward those who were loyal. In the 1700s and 1800s annuities were popular with European high society. Their popularity is not surprising since annuities could shelter the investors from many of the ups and downs experienced in other markets.
Compared to other areas of the world, annuity use grew very slowly in the United States. Annuities were mainly purchased to provide income in situations where no other means of providing support could be found. Americans were more likely to rely on support from family members. Annuities were mostly purchased by lawyers or executors of estates who needed to provide income to a beneficiary as described in a last will and testament.
Annuities finally gained some popularity due to the spreading out of American families at the turn of the 20th century. There were fewer family members available to provide care for other family members during illness or as they aged. The Great Depression was especially significant in the history of annuities. Until then, annuities represented just 1.5 percent of life insurance premiums collected between 1866 and 1920 in the U.S. During the Great Depression investors sought out more reliable investments in order to safeguard themselves from financial ruin. With an unstable economy, investors looked to insurance companies as a haven of stability when few other investments appeared to have any security at all.
Annuity Terminology
All legal contracts use terminology specific to them. Agents must be aware of all terms and conditions in the legal contracts they sell – insurance policies and annuities. Agents must also be able to communicate well enough to explain in lay terms what these terms mean to the policyholders and their beneficiaries.
1035 Exchange
As specified by the tax code, section 1035(a), permits a (usually) tax-free funds transfer from annuity to annuity; the 1035 exchange excludes the transfer of funds within an annuity from one subaccount to another.
403 (b)
Similar to a 401(k), the 403(b) is a tax-deferred retirement savings account offered to employees of nonprofit organizations, through which contributors invest in annuities (often referred to as TSAs) or in mutual funds.
10% Penalty Tax
As it applies to annuities, a 10 percent IRS fee charged upon the withdrawal of pretax savings (contributions or earnings) from an annuity before the age of 59 ½.
Asset Allocation
In a variable annuity, asset allocation is the distribution of assets across multiple classes (such as stocks, bonds, and cash) in order to meet an individual’s financial goals in terms of risk and length of investment. Asset Allocation can reduce risk and maximize returns on the investment.
Back-End Charge
Fees incurred by an investor for cashing out early on a deferred annuity or variable annuity, usually within the first 7 to 10 years after investing (depositing). This is often called a surrender charge.
Bailout Provision
If a fixed annuity’s interest rate falls unpredictably below a rate specified in the annuity contract, the provision assures the surrender-charge-free withdrawal of all funds from the under-performing annuity account.
Balance Inquiry
A balance inquiry is an on-line tool allowing contract holders to check the balance of all accounts held within their annuity.
Benchmark Index
An index that measures the performance of market allocations in a variable annuity. A benchmark index also compares performance between a variable annuity and an investment portfolio. These indices cannot be invested in directly; also, in contrast to an investment portfolio, these indices do not require that transaction fees and other costs be paid by an investor. These may also be called stock or bond indices.
Beneficiary
The individual, organization, or entity that receives money upon the death of an immediate annuity contract holder. It may also include the person, organization or entity that benefits from continuing payments upon the death of an immediate annuity contract holder that has not yet received all of the guaranteed income stream for the contractual time period of the annuity.
Beta (3 year)
A percentage reflecting the relative volatility of the subaccounts in a variable annuity as compared to the market as a whole (often determined using the S&P 500). A value greater than 1 percent is indicative of volatility over the market.
Bonus Rate
The bonus rate is extra interest accumulated in the first year of a deferred annuity that is added to the sum upon which interest is calculated in later years. Also called the first-year bonus rate.
Certificate Owner
The purchaser of an annuity, whether an individual, organization, or entity.
Compound Earnings
In a deferred annuity, the reinvestment of previous interest earnings back into the annuity account.
Contingent Annuitant
In the case of the death of an annuitant prior to the beginning of annuity payments, the person who is designated to receive the payments in the original annuitant’s place.
Contingent Deferred Sales Charge (CDSC)
A fee charged to the account of a deferred annuity or variable annuity upon the full surrender of an annuity contract or upon the withdrawal of funds in excess of annuity contract limits.
Contract Owner
The purchaser of an annuity contract and holder of all rights pertaining to it. With a variable deferred annuity, this person or entity may have rights extending to making investment decisions, initiating monetary transfer and redistribution among funding elements, withdrawal rights, and the naming of the annuitant (usually the contract holder) and any beneficiaries.
Death Benefit
The death benefit is a guarantee of payment of the annuity account value or a different, specified amount (such as the value of the original lump sum funding payment minus withdrawals) to designated account beneficiaries upon the early death of an annuitant or annuity contract holder, before the deferred annuity or variable annuity is annuitized (before the annuity is converted into systematic payouts). In many variable annuities the value of the death benefit increases over time, and several kinds of death benefits exist: the greater of the value of the current account or the value of the initial funding payment; rising floor, in which the insurance company provides a guaranteed minimum return, regardless of the performance of any annuity subaccounts, on any deposits; Ratchet, the greater of the values of the contract, any payments minus all withdrawals, or the contract on a given date; and Stepped-up, guaranteeing payment of the value of the annuity account as per set anniversary dates (e.g., on a yearly periodic basis).
Deferred Annuity
Deferred annuities feature a contract with accumulation and can be funded either through a one-time lump sum payment or through multiple payments over time. Any investment accumulates over the years with a tax-deferred status. Deferred annuities can be variable or fixed. When chosen by the policy owner payments from the annuity begin through annuitization options.
Direct Rollover
A monetary transfer classified as a rollover but which occurs from one investment company directly to another, often from one investment plan into another (such as from a 401(k) plan into an IRA account). Direct rollovers must be reported but are not taxed, and therefore annuitants can avoid taxation of distributions by using this method.
Diversification
In a variable annuity, a method that helps an annuitant reduce or avoid risk by distributing funds over multiple asset classes; for example, an annuitant could diversify by investing in stocks within different industries.
Dollar Cost Averaging
In a variable annuity, dollar cost averaging is the investment of a fixed amount of dollars at regular intervals. This is a financial strategy that could eventually ensure that the average cost per unit will fall below the average price or the market high; however, it does not guarantee profit or guarantee the avoidance of a loss. Investors must invest in securities on a continual basis despite any fluctuation in prices and should assure his or her ability to continue purchasing in times of low prices before using this strategy.
Effective Annual Yield
In a deferred annuity, the rate used after the daily compounding and crediting of the annuity’s interest. The effective annual yield includes any first-year bonus and can be calculated as follows: using the rate bonus, a bonus paid on the base rate by some annuities (e.g., with a 6 percent base rate and a 1 percent first-year bonus, the effective annual yield will be 7 percent), and using the premium bonus, paid upfront by some annuities (e.g., with a 6 percent base rate and a 1 percent premium bonus, the effective annual yield might be 7.06 percent).
Effective Interest Rate
The interest rate when an annuity is compounded annually. For example, with an initial $10,000 deferred annuity investment, over one year at an effective rate of 10%, $1,000 will be earned in interest. This is also called an annual effective rate or an annual effective yield.
Enhanced Dollar Cost Averaging Program
In a fixed annuity, a dollar cost averaging program providing an often higher interest rate in particular cases, e.g., for new minimum purchase payments within a limited period of time. Specified amounts are usually transferred automatically over a given time period from a fixed to an investment account.
Equity Index
In equity-indexed annuities, equity index is the index used to measure the performance of stocks or bonds selected for indexing the annuity, with an increase in performance resulting in an increase in the value of the equity-indexed annuity.
Equity-Indexed Annuities
A type of annuity offering a guaranteed minimum return rate; may also offer additional interest earnings based on the value of an equity index. The indices used for determining the value of an equity-indexed annuity are commonly well-known stock indices, such as the S&P 500.
Equity Investment Style
Within an annuity, the combination of investment types used.
Exclusion Ratio
The ratio of taxable to nontaxable proceeds in an immediate annuity payment.
Expense Ratio
The percentage of an annuity account that is paid on a yearly basis toward insurance and investment charges.
Immediate annuities guarantee a systematic stream of income. They are funded by a lump sum payment to an insurance company. In a given annuity period, e.g., monthly or yearly, an immediate annuity provides payments composed of both the principal and any interest earnings; payments will, over time, liquidate the principal. Immediate annuities are often purchased for the purpose of providing income during retirement.
Surrender Penalty
Fee charged to a deferred annuity account for excessive or multiple withdrawals that exceed the limits imposed by the annuity contract. Upon the surrender of the entire annuity, the penalty could be assessed according to the total annuity account value.
Surrender Value
Value of an annuity account minus any surrender penalties paid, as laid out in the annuity contract.
Yield
Yield is the annuity’s rate of return. Often a percentage of earnings in
relation to the annuity balance.
Annuity Basics
There are many annuity products in the marketplace. Even agents may have difficulty discerning the differences; certainly it is difficult for the annuity buyers. There are many different products available under the fixed and variable annuity headings: tax-deferred, guaranteed, inherited, equity indexed, and more. While there are only two basic types of annuities (fixed and variable) each has many sub-types and marketing names. Insurers often market their products under company names making it difficult to compare apples to apples.
Annuities are tax-deferred investment vehicles. Investors deposit their money either in a lump sum or through a series of contributions. Although annuities are marketed by many different entities, they are always placed with a life insurance company that sells annuities (the annuity issuer). The period of time the annuity is being funded is known as the accumulation phase. In exchange for investing in the annuity, the insurer promises to make payments to the investor and possibly a named beneficiary at some point in the future. When the annuity vehicle begins paying the annuitant a monthly income it is known as the distribution phase. For many investors, the distribution phase begins at the point of retirement, but that is seldom mandatory. Many annuity investors never annuitize their contract, so the entire amount continues to grow. Upon the death of the annuitant, the annuity funds would then go to the named beneficiaries. If no beneficiary was designated, upon the annuitant’s death, the un-annuitized accumulations would go to the annuitant’s estate. Of course, a beneficiary should always be listed as well as a contingent beneficiary designation in case the primary beneficiary predeceased the annuitant.
These annuity terms generally refer to the different features that can be applied to the basic annuity product. Some of these features are great for retirees and are options recommended by the most respected financial planners in the country. Other annuity features are almost universally condemned by the same planners. Therefore, it is important to understand these options so you can determine which annuity is most appropriate for your clients.
Choosing Between Fixed and Variable Annuities
Perhaps the most important consideration to make when evaluating annuities is whether to choose a fixed or variable annuity. Each has its proper place, but neither is right for everyone and every situation.
Fixed annuities are typically based on fixed income products, such as bonds and once annuitized, pay a guaranteed stream of income. It is a fixed annuity because the income stream is “fixed.” The annuitant knows how much income will be received each and every month once annuitization takes place. Of course, annuitization is not mandatory and many annuities are never annuitized. Even so, the insurer’s intent when selling these products is to provide a stream of income – for the annuitant’s life if that is the payout option selected.
The fixed annuity guarantees the investor a specified income – no matter what – which makes fixed annuities a good choice for retirement financial planning. Guaranteeing an income during retirement is a common financial planning goal. It is important, however, to note that there will be no adjustments in the annuity income for inflation or rising costs of living. The specified amount continues to be the same regardless of these factors unless steps have been taken to counteract this situation. The investor can elect to pay extra for an annual Cost of Living increase or inflation protection as an option on the annuity contract.
Variable annuities are typically based on mutual funds and pay a stream of income that moves up and down with changes in the value of the underlying funds. A variable annuity is a riskier investment for retirement since there are no guarantees as to monthly income.
Many financial retirement planners recommend fixed annuities since retirement is generally a time in life when risk must be avoided. There are no wages and little time to make up potential losses once the investor enters retirement. Fixed annuities are less risky and provide a more reliable income stream. Some planners might recommend primarily fixed annuities with a smaller amount invested in variable annuities if the specific situation allows this without putting the retiree in a precarious situation.
Choosing Between a Lifetime Annuity and Term Annuity
Lifetime annuities are annuities that pay an income stream when annuitized for the remainder of the investor’s life – no matter how long he or she lives. In fact, depending on how long the investor lives, a lifetime annuity could pay a higher sum over the investor’s lifetime than originally invested in the annuity. The opposite could also be true – the investor could die before recouping their investment. Because of this, many annuity products offer premium protection – insuring that the investor or their heirs will receive back at least as much as was invested. It all depends upon the payout option chosen. Payout options should never be selected until full understanding exists.
Lifetime annuity payout options are a good choice for those who want to guarantee additional income beyond an existing pension or Social Security payments. The annuity does not need to be annuitized at any particular time so the retiree can hold funds in the contract until additional income is needed or desired. Once annuitized, the income stream will not change so it is important to annuitize only when the income is actually needed.
Term annuities result from selecting payout options that pay the investor an income stream for a specified period of time that he or she selects (versus lifetime income). Term and lifetime annuities are actually the same annuity product – the selected payout option is what results in one or the other annuity product.
Most annuities have several withdrawal or annuitization options. Most annuities will allow the investor to withdraw portions of the earned interest once or twice each year without actually annuitizing the annuity contract.
There are several annuitization options:
§ Life-time income, which provides income only to the annuitant. It is often referred to as a Straight Life Income option. If the annuitant dies before all invested funds are collected, the insurer keeps any balances. There is no beneficiary designation because beneficiaries do not receive any leftover cash. This option is selected by those who want to maximize their monthly income, since it pays the highest amount among the payout options. This should not be surprising since beneficiaries will not receive anything and the insurer could come out ahead if the investor dies prematurely.
§ Life-time and Period Certain, which guarantees income for a specific time period selected by the annuitant. There are several time periods offered, such as 5, 10 or 20 years, plus a life-time income if the annuitant lives beyond the time period that is guaranteed. If the annuitant dies within the guaranteed period certain, his or her beneficiaries will receive the balance of that guaranteed time period. Only the annuitant can receive a life-time income; beneficiaries would receive nothing beyond the specified time period. This payout option will provide less income each month than the life-time option because there are beneficiaries listed that may receive income if the annuitant dies prematurely. These may also be called Guaranteed and then for Life annuities, but they are really a payout method rather than a type of annuity.
§ Period Certain, (also called Term payouts) that pay for the time period selected but stops paying once that point or term is reached. For example, if a twenty year payout is selected, the annuity company will pay for twenty years only. Once that has been accomplished payments cease. These typically continue to pay beneficiaries according to the payout selected by the annuitant so if the annuitant selected a 10 year payout, died after receiving 7 years of income, the beneficiary would continue receiving the same income for the remaining three contract years. This option will pay more than the Life-time and Period Certain because the insurer knows it will not pay beyond the time period selected. These may be called Twenty Year Term annuities (or Ten Year Term, depending on the time period selected),
§ Lump Sum, which is exactly what the name implies – the annuitant takes the entire amount in the annuity in a single lump sum payment.
§ Joint-and-Survivorship, which covers the lives of two or more named individuals. These annuities are often used by married couples, but they can be utilized by any two or more individuals.
Agents and consumers will see payout options with a variety of names, but usually each type is more a description of the payout than a new type of annuity. Many of the other options have to do with additions added to the standard five payouts, such as an attached life insurance policy or inflation protection.
It is common to see annuity payout options listed as the annuity type. For example, a brochure may call an annuity a Guaranteed-and-then-for-Life annuity. This is actually the payout option described as the annuity. The annuity is a fixed annuity that will pay for a period certain and then for the lifetime of the annuitant if he or she lives beyond the time period selected. It could just as easily be called a Ten-Year Annuity or a Twenty-Year Annuity. It each case, however, it is actually a fixed rate annuity with a payout term of ten or twenty years.
How does the annuitant determine whether a life-time income (that pays less each month) or a specific term (that pays a higher amount each month) is the best selection? Since the retiree has no way to know how long he or she will live, it may be more a question of looking at the entire retirement income picture when making the decision. Many retirement specialists automatically favor a lifetime payout option since that ensures income up to the time of death and will also mean the highest amount of income each month. It is unlikely that monthly living costs will go down, so it is unlikely that less income will be needed in the final years of life. Obviously less income is what would result once a term annuity payout met the end of its term and stopped providing income. A lifetime annuity guarantees retirement income until death. On the other hand, family members are seldom happy to find out that there will be no inheritance if the retiree dies prematurely. No one likes knowing the insurance company will keep any remaining funds. Many annuitants end up selecting a life-time with Period Certain payout option to get life-time income while still guaranteeing either the annuitant or the beneficiaries will receive their investment principal. This option will pay less than the straight life-time option.
Company Financial Strength
Annuities are usually long-term investments so it is very important that the company selected be financially strong. Of course, agents should always use only top rated companies, but this becomes especially important for long-term vehicles. Unlike bank accounts, the federal government does not guarantee annuities. Since the company is promising lifetime income, the consumer also wants to be sure the insurance company is operating as long as their lifetime.
Annuity Extras
Principal Protection
Some payout options guarantee the annuitant or their beneficiaries will receive at least all the principal back. In other words, if the annuitant dies before collecting every last dollar he or she paid into the annuity, their named beneficiaries will receive the balance. Also called premium protection, the annuitant will continue to receive periodic annuity payments until the cumulative annuity payments equal the net investment. This is often stated as a type of annuity, but it is actually a payout option. As such, it will not provide as much monthly income as a straight life payout option will because the annuity company is accepting a higher level of risk.
Cost of Living Protection
It is possible to choose an annuity with automatic cost-of-living adjustments. When an annuity is purchased it is often for the purpose of receiving a certain amount of monthly income. As we know, inflation can dramatically decrease the buying power of that income over time. An annuity with “cost of living adjustments” (COLA) protects the value of the annuity income stream by adjusting the payments along with inflation or the cost of living. Inflation protection or cost of living adjustments can be very important in maintaining accustomed lifestyle during retirement. Nothing is free however. This feature comes with a price tag, usually in the form of lower monthly income than a straight life annuity payout.
Annuities go in and out of favor, usually depending on how the stock market is currently performing. When stocks are performing well, financial planners may condemn annuities as too conservative, providing low returns. When the stock market is performing poorly, however, annuities suddenly gain popularity due to their guarantees of principal and some amount of guaranteed interest earning. Annuities have always offered specific benefits over other kinds of retirement products, especially for those not able or willing to risk losing a portion of their retirement savings.
Principal Protection is an important feature of fixed and equity indexed annuities. Agents should be stressing this very important retirement investment feature. Additionally, most annuities guarantee a minimal amount of interest earnings. In the past, the amount of interest paid was usually higher than minimum guarantees, but when stock market performance became very dismal, those minimum guarantees provided more earnings than many stocks were able to do. Depending on the payout option chosen, it is also possible to guarantee that the annuitant or their heirs will receive back at least as much money as was invested in the annuity.
Tax Efficiency
The purchase of an annuity with qualified retirement savings, such as funds from a 401(k) plan or an IRA, can save the investor money on his or her taxes when compared to taking a lump sum payment. Qualified funds can be rolled into a qualified annuity without any tax penalties. The annuitant only pays taxes on the income the annuity provides.
An annuity, like all investments, is not perfect, but it is a great way to protect one’s quality of life in retirement. Retirement assets can be used to purchase guaranteed income for a specified time period or for the life of the investor and his or her spouse. Annuities provide many payout choices for the investor allowing him or her the freedom to make their own income choices in retirement.
Supplementing Other Retirement Income
Most financial planners would probably urge employees to first max out their 401(k) plan, if such a plan is available. This is sound advice since employers often match in part or whole the funds contributed by the employee. At some point, if the employee is financially savvy, he or she may max out their 401(k) plan since, unlike an annuity, there are limitations. Once the 401(k) plan has been maxed out, an annuity becomes an excellent financial vehicle to contribute to. The earnings will be tax-deferred, meaning the interest earned does not affect current taxation. Earnings are not taxable until they are withdrawn. At one time, investors could claim they were first withdrawing the principal, which had already been taxed. Now the IRS says interest earnings are always withdrawn first, so taxes would be due on the interest portion. This is often called the “last-in-first-out” rule.
Reasons to Buy an Annuity
There are many good reasons to buy an annuity including:
Reasons to Avoid Buying Annuities
No investment is right for every person. Annuities aren't right for everyone either. Some potential drawbacks include:
Making the Right Annuity Choices
Often it is not whether an annuity is the right vehicle, but rather if the annuity product chosen meets the investor’s needs. Choosing the right type of annuity can be critical to meeting investment goals. Consumers seldom know which annuity type best suits their needs, so it is typically the agent that must provide enough information for the correct choice to be made. It is important that agents not pre-judge the client’s goals, thus failing to provide full information.
The first step is determining the client’s goals in order to fully understand which annuity is likely to be appropriate. Often the goal is retirement income. Determine exactly when the client expects to begin receiving annuity income. Is he or she near retirement or years away from that date?
If the client is nearing retirement age, it is possible that he or she has a lump sum to deposit but if the client is much younger, it is likely that periodic payments will be made into the annuity vehicle, called a deferred annuity. A deferred annuity takes many years to accumulate cash build-ups and does not begin paying an income stream for many years.
For those either coming to or already in retirement an immediate annuity may be their goal, but not everyone annuitizes their annuity so even this should not be automatically assumed. As we know, an immediate annuity immediately begins paying an income stream to the annuitant. How long that income stream lasts will depend upon the payout option chosen at the time of annuitization. Payout options include a life time income stream but it is important to realize that the amount received each month is directly related to the amount of cash in the annuity. Obviously if the client has only accumulated a few thousand dollars, the monthly income will be very little – certainly inadequate to support the individual in retirement.
That brings us to the second step: how the annuity funds should be invested. With a fixed annuity, the annuity issuer determines an interest rate to credit to the investment account. An immediate fixed annuity guarantees a particular rate, and the payment amount never varies. A deferred fixed annuity guarantees the rate for a certain number of years; the rate then fluctuates from year to year as market interest rates change. A variable annuity, whether immediate or deferred, gives the investor more control and the chance to earn a better rate of return (although with a greater potential for gain comes a greater potential for loss). The annuity investor selects their investments from the separate accounts (similar to mutual funds) that the annuity issuer offers. The payment amount will vary based on how the investments perform.
Many Annuity Choices
Unfortunately agents do not always have the freedom needed to shop around for the right annuity. In some companies, the products are chosen by the brokerage and the agents have only those products to represent. However, agents do have the freedom to work elsewhere if the products represent more advantages to the company than to the agent’s clients. Some annuity products provide hundreds of dollars more each year than others. Why? Rates of return and out-of-pocket costs for clients can vary widely between different annuities. Of course, the insurer chosen should be reputable and financially sound as well. Refer to one or more rating agencies to determine an insurance company’s financial strength, investment performance, and other factors. Most professionals recommend checking more than one rating agency since their reports are a mixture of information. Check to see how the rating agency makes their determination as well; do they do their own research or do they rely solely on the information volunteered by the insurer?
Not all annuities are the same, although the differences are sometimes vague. The financial planning community views some annuities (particularly fixed annuities) as being the ideal solution to a retiree's need for guaranteed income because they have a very good reputation. However, some annuity products are viewed as unnecessary and very expensive. Whether or not this is true is partially opinion and partially fact in many cases, but it is important to know all the annuity features – both good and bad - prior to selling them. At no time should an agent ever omit facts when presenting annuities or any other insurance product to the client.
When stocks are performing well, fixed annuities are accused of giving lower returns than available elsewhere and this is often true. What investors and even financial planners may fail to take into consideration is the safety annuities offer. Safe investments always pay lower returns than riskier investments. Recent lows in the stock market have emphasized this very well. In return for the retirement income certainty provided by fixed annuities or equity indexed annuities the investor gives up the opportunity to make bigger returns by investing their money in assets that fluctuate in value, as stocks do. Even the safer mutual funds have seen downturns recently, again emphasizing the safety of fixed rate annuities. A fixed annuity is considered to be a safe and conservative investment but this means the investor will not see the possible gains (and losses) of a riskier investment – like the stock market.
Although it is not necessary to annuitize, annuities are designed to do just that in order to provide monthly income. A problem with annuitizing, however, is the inflexibility that results from annuitization. Annuities are typically less flexible than some other retirement options; once the annuity contract is annuitized the capital is tied up in the annuity, meaning the annuitant no longer has access to that lump of money. Perhaps that is why so many annuities are never annuitized. Perhaps the investor prefers taking out sums of money periodically rather than receiving a guaranteed income stream. Some retirement planners recommend their clients reserve at least 40 percent of their retirement assets for unforeseen circumstances. Annuitized annuities are not ideally suited to cover large unplanned expenses but if the contract is never annuitized it may be possible to use them for such things (depending on whether or not the annuity is still in the early years when there could be surrender fees involved).
Annuity products can be structured to strengthen an individual’s retirement financial plan. As we seem to be repeating in this course, the best type of annuity for retirement is a fixed lifetime annuity. Many planners would recommend an annual Cost of Living Adjustment that protects the income from the effects of inflation be included. A fixed lifetime annuity gives the investor an income stream for the rest of his or her life – no matter how long he or she lives and it offers a guaranteed payment regardless of stock market performance.
Annuity products are not perfect. Although they provide exactly what most retirees need - guaranteed income – annuities also tie up the capital, so the investor loses flexibility. However, trading flexibility for guaranteed income is not necessarily bad. One of the major retirement mistakes is over-spending in the early years of retirement, so the inflexibility may actually be an advantage, although some planners consider it a downside to using annuities. Since so many people do over-spend in the first twenty years of retirement (using up all their savings when they still have another ten years of living) perhaps it is a good thing that annuities do not allow the investor to dip into the lump sum of money held in the annuities; perhaps that is a selling point – not a disadvantage after all.
As every agent should know, not all annuities are created equal and many annuity products and features are actually a bad feature for retirees. In addition to choosing between a fixed (mostly recommended) or variable (riskier) annuity, there is also the matter of deciding where to purchase the annuity. Of course, agents would prefer to be the selling entity but they are available from many sources. Although the underwriting is always done by an insurer, annuity products can be purchased through banks, loan companies, and many other institutions.
Annuities for Retirement
The most common problem in retirement is living longer than the money lasts. Of course, some of this is created by the retirees themselves. They make large purchases that should not be made (such as travel homes, for example) or over-spend in the early years. Many surveys show a major problem is underestimating at age 65 how long they are likely to live. Many new retirees plan for twenty years of living when they should be planning for 30 years in retirement.
Another error is failing to plan for the effects of inflation and rising costs of living. Today’s costs will probably not be tomorrow’s. Retirees must plan on needing progressively more money to cover the same routine bills. Gasoline goes up, electricity goes up, and property taxes go up. Seldom do any of our routine expenses go down over time. Retirement can be golden but if the retiree failed to adequately plan ahead with enough savings and investments the final years may mean poverty. Annuities are a great way to secure the future with continued income. Each person is responsible for his or her own retirement future. Financial mistakes can seldom be reversed once retirement begins.
Everyone is Living Longer These Days
We have always heard that women live longer than men, and that is still true
– for now. However, both men and women are living longer. Those who reach age
60 have a very good chance of living into their eighties and nineties. In
addition, the longevity gap between men and women is closing. Some 20 years
ago, a woman aged 60 could expect to live for another 22 years, while a man of
60 could only expect to live for another 17 years. Now, a man who reaches age
60 can expect to live for another 21 years and a woman for another 25 years.
Although the gap is closing, currently the life industry expects women to
live longer than men and so pays women a lower monthly pension amount. People
who survive to 60 are living longer because of improved medical care, a greater
willingness to go for check-ups and medical treatment, better screening for
diseases, better education about diseases and how to treat them, and improved
access to treatment. Many feel longer life is also a product of our increased
willingness to stay physically active long into our retirement.
Coutts-Trotter and Peter Bond, the chief medical officer at Old Mutual
Insurance, say the life expectancy of men has improved faster than women
because:
Putting Off Retirement
When the retirement accounts of many Americans dropped by up to 45 percent in 2008 and 2009 due to drops in the stock market many people who had planned to retire were forced to rethink their retirement date. Individuals lucky enough to have a guaranteed pension through their employers were suddenly the lucky few. Most people fund their own pension plans, whether through 401(k) plans, Individual Retirement Accounts, or simply by putting away a few dollars whenever possible. Those who are self-employed (as most insurance agents are) must especially be diligent in planning for their eventual retirement. The question is always the same: will I outlive the wealth I have created?
Each person must personally be responsible for their own retirement. While any financial planner will gladly help a client figure out their future, none can guarantee that all will be fine. Ultimately it is always up to the worker to save adequately for retirement.
Annuities always look better to financial planners when stocks are down, but even when they have not been down, annuities continued to be used to some extent. Annuities got a famously bad rap in the 1990s because of their unfamiliar - and surprisingly steep - fees. Since then, the variety of annuity products have expanded and some of the fees are down, especially if the agent shops around for products to represent. In recent years, annuities have offered so much personalization that just about everyone can find one they like. That does not mean that the annuitant will have saved adequately. While everyone agrees that saving something is better than saving nothing, inadequate savings is not a solution. We know by now that Social Security is not adequate to live on, yet fewer people are putting away money for their retirement. As a result, many older people are deciding to retire later than they otherwise might have. Unfortunately job layoffs are affecting those who would have liked to continue working.
No matter how many bells and whistles are added to them, annuities still come in the two basic formats: fixed and variable. As we have said, fixed annuities yield a steady stream of income for a set number of years or the rest of the investor’s life. Variable annuities can also provide regular checks, but they tie the amount of payouts to the performance of an investment portfolio. Both types allow the individual investor to choose whether to begin receiving payouts immediately (in monthly, quarterly, or annual installments) or at a later date; both varieties pay out partly taxable money - taxed only on gains, not the original investment - at regular income tax rates, an important fact to weigh when considering annuities for any financial plan.
Annuities are offering a wider variety of options, but they really are just that: options. Fixed annuities can be purchased with inflation protection added to the payouts; a death benefit can also be attached to the annuity. Some policies offer an option for long-term-care insurance, which raises the payouts if the investor becomes disabled. On certain variable annuities, the investor can opt to have their portfolio value (and therefore their payouts) reflect the performance only in neutral or good years.
All options typically come with a price tag. Clients should never be allowed to assume anything different. For fixed annuities, the price comparisons among different firms’ offerings are relatively simple: "It all comes down to how much money you put in and what initial payment that produces," says a T. Rowe Price senior financial advisor.
On variable annuities, the cost of a specific feature is usually expressed as percentage points deducted from your returns. Unfortunately, few clients would realize this so it is up to the agent to inform them. Only if the client actually wants a feature should it be included. Features that limit downside investment risk tend to cost anywhere from 1¼ to 1½ percentage points deducted from the annual portfolio returns. That is on top of annual investment-management fees, which vary among companies and even among products of the same company.
For fixed-annuity holders, financial planners often feel the most important extra to consider is inflation protection. Even modest price increases can damage purchasing power over time. For example, an individual retiring on $100,000 a year in 1980 would need $253,000 a year today to maintain the same lifestyle. Inflation protection in the form of annual adjustments to income from the annuity is costly. It will reduce about 30% from the first payout received. Even so, it may be worthwhile considering that the insurance company takes on a big unknown – namely, how long the investor will live.
Not everyone will be willing to reduce their initial fixed annuity payouts by 30 percent. Perhaps their level of savings was too low, for example, to permit such a reduction. If inflation protection seems too expensive, the investor could buy a policy with an escalation clause, stipulating a lower annual payout increase (in other words, less than the actual inflation rate). This still comes at a price however. It may reduce initial payouts by 25 percent - less than the 30 percent for actual inflation rates, but still pricey. Notes T. Rowe Price’s advisor: "I like this feature because it's more affordable, and it keeps you apace with inflation in all but the really bad years."
Most of us purchase fire, health and car insurance, yet we fail to protect the most serious risk faced in retirement: living longer than our assets. Our second retirement failing is underestimating the cost to live decently in retirement. Guaranteeing a monthly income is not the same as guaranteeing an adequate monthly income during retirement. Agents cannot do this for their clients; if the client has saved inadequately, all their agent can do is provide some income – not necessarily adequate retirement income.
An annuity could be compared to a pension plan since it will provide income to the end of one’s life. The difference is important however: the investor must fund this annuity pension because there is no employer doing it for them. That’s unfortunate since the employer would make sure the pension was funded each and every month. The private investor may not necessarily do so.
Fixed Rate Annuities
An annuity is a contract purchased with a sum of money to provide the buyer or annuitant with regular payments in return. Annuities work like loans in that an individual purchases an annuity from a company and gives the company a large sum of money. In return, the company pays back the sum of money over a period of time plus interest. Typically taxes are deferred on annuities until the payments are made to the annuitant.
How Fixed Period Annuities Work
Annuities can vary in amounts paid, frequency of payments, and time periods over which the payments are made. Under some circumstances an individual annuitant can decide either how much is paid in each payment or the period of time over which payments are made. Since the total sum of money received each month is decided upon by the amount held in the annuity at the time of annuitization, a shorter fixed period annuity would typically have larger payments to the annuitant than a longer fixed period annuity. In some cases, a life time annuity payout would be very little each month if the amount saved in the annuity was inadequate.
If the annuitant wants a specific amount of income each month that amount would determine how long monthly payments could be made. Obviously, it requires sufficient funding to provide specific amounts of income each month for a long time period. There are typically multiple payout options available for each annuity. That would not necessarily mean all payout options would produce the results desired by the annuitant since it all comes down to how much he or she saved.
Fixed period annuities are annuities where the individual annuitant or owner/purchaser of the annuity chooses the amount of time over which the annuity is paid back. Fixed annuities pay a fixed amount over a fixed period of time chosen by the annuitant. The amount of time is usually a function of many years (such as ten or fifteen years) during which annual, bi-annual, or monthly payments are made to the annuitant. Fixed period annuities usually offer the following payout categories:
Many industry experts feel too little time and thought is given when selecting payout options. Annuitants often assume that beneficiaries will always receive remaining investment funds, even when that is not the case. It is a foolish agent that does not fully communicate the situations under which beneficiaries receive nothing. Many industry experts recommend using a disclaimer when the annuitant chooses to take the maximum payment, leaving nothing to their heirs. Having the annuitant sign such a disclaimer stating that he or she fully realized their beneficiaries would receive nothing prevents discontent or even legal action following the annuitant’s death.
Variable Annuities
A variable annuity is basically a tax-deferred investment vehicle that comes with an insurance contract designed to protect the investor from a loss in capital. Thanks to the insurance involvement, earnings inside the annuity grow tax-deferred and the account is not subject to annual contribution limits. In a variable annuity the investor chooses from among a range of different investment options, typically mutual funds. The rate of return on the purchase payments, and the amount of the periodic payments eventually received will vary depending on the performance of the investment options the annuitant selected.
Generally the investor chooses from a menu of mutual funds, known as "subaccounts." Withdrawals made after age 59½ are taxed as income. Like most annuities, earlier withdrawals are subject to tax and a 10% IRS penalty.
Variable annuities can be either immediate or deferred. With a deferred annuity the account grows until the investor chooses to begin withdrawals, which should be after age 59½ to avoid penalties. The annuity may be annuitized, using one of the payout options, or the investor can withdraw money as he or she wishes (never annuitizing the contract).
Like most annuities, variable annuities are long term investments. The longer the annuitant allows their money to build, the more he or she is likely to gain from the investment. However, unlike a fixed annuity (where the funds sit in an account from which payments provide a fixed income throughout a fixed time period), a variable annuity gives the investor more control over their investment but also gives the investor the burden of risk. There should be no mistake on this point – variable annuities do include investment risk.
The money deposited into variable annuities can go into the investor’s own account, separate from the investment portfolio of their broker or insurance company. The investment choices are, therefore, the investor’s to make.
As one nears retirement, it often wise to avoid riskier investments since the time to make up losses is not there. Younger investors are more likely to favor variable products since they do have time on their side and they may actually enjoy involving themselves in the investment choices. These investors may want to play the money market, or invest in stocks, bonds, or equity funds. The variable annuity returns depend on the account's performance rather than just rising and falling with the fortunes of the firm that holds it.
Variable annuities often provide a wider spectrum of investment opportunities for retirement savings, while providing professionally managed fund options as well.
Annual Expenses
The investor’s broker or insurance company may guarantee the principal investment, minus withdrawals for any of the following annual expenses.
Agents should never assume that the percentages or costs we have listed apply to all annuity products. Companies continue to change, add, or delete features as they try to gain additional clients, market shares, or correct faults within the products.
Funding Variable Annuities
Investors should first maximize their retirement options as far as their individual retirement accounts (IRA) or employer-sponsored programs are concerned. If the investor still has some money they still wish to invest towards their retirement, then a variable annuity could be a good option. Since this is a risk vehicle, few professionals would recommend it as the only retirement investment.
It is possible to either purchase a variable annuity outright or make regular deposits to it over time. The investor usually has the option of trading any current annuity for a variable annuity. However, transferring funds from an already tax-deferred plan, such as a 401(k) plan, into a variable annuity will not add value to the investment since the investor would just be paying their broker fees for tax deferral they already have.
Popularity is no indicator of practicality. Not everyone needs an annuity and certainly not everyone should buy a variable annuity due to the risk involved. Many professionals favor buying plain old mutual funds over annuities, although mutual funds lend themselves to spending mistakes in retirement that may be avoided with an annuitized annuity.
Variable Annuity Fees
Variable annuities do have fees. Some financial planners feel the amount of
fees are extravagant in some variable annuity products, so the wise agent will
certainly shop around for the products they want to represent.
Variable Annuity Death Benefit
The variable annuity death benefit basically guarantees the account will hold
a certain value should the annuitant die prior to annuity payments beginning. With
basic accounts, this typically means the beneficiary will at least receive the
total amount invested even if the account has lost money. For an added fee
this figure can be periodically increased. If the investor decides not to
annuitize the death benefit typically expires at a specified age, often around
75 years old.
Surrender Fees
Most annuities have surrender fees that are due if the investor does not keep
the annuity for several years. The actual length of surrender fees varies, but
they are usually between five and ten years, with seven years being common.
Withdrawing funds during this time will result in fines, although many
annuities allow the interest earnings to be withdrawn penalty free. Surrender
fees typically decrease as the years go by, often by a percentage point each
year. For example, in a five year surrender period, the first year may impose
a 6 percent penalty, 5 percent the second year, 4 percent the third year, 3 the
fourth year, and 2 percent in the fifth and final year. Always consult the
contract for exact penalties.
Early Withdrawal Penalty
As with most retirement accounts, if the investor withdraws funds prior to
age 59½, he or she will be charged a 10% early withdrawal tax penalty.
Taxation
Gains in variable annuities are taxed at ordinary income tax rates, which can
be high. In fact it can be substantially higher than their taxes on long-term
mutual fund gains. The difference can eat up the advantage of an annuity's
tax-free compounding. It may take from 15 to 20 years before tax-deferred
annuities become more tax efficient than a mutual fund, even though the mutual
fund is not tax-deferred. However, many people do keep annuities for 15 to 20
years or even longer. Additionally, many people are not looking at how the
gains will be taxed because funds will be gradually withdrawn as lifetime
income or because they will be in a lower tax bracket in retirement.
Equity-Indexed Annuities
An equity-indexed annuity is a special type of annuity. During the accumulation period the insurance company credits the investor with a return that is based on changes in an equity index, such as the S&P 500 Composite Stock Price Index. The insurance company typically guarantees a minimum return. Guaranteed minimum return rates vary. After the accumulation period, the insurance company will make periodic payments to the annuitant under the terms of the annuity contract, unless the annuitant decides to receive their contract value in a lump sum.
Variable annuities are securities regulated by the SEC. Fixed annuities are not securities and are not regulated by the SEC. Equity-indexed annuities combine features of traditional insurance products (guaranteed minimum returns) and traditional securities (returns linked to equity markets). Depending on the mix of features, an equity-indexed annuity may or may not be a security. The typical equity-indexed annuity is not registered with the SEC.
End of Chapter 6
[1] The History Collection
[2] The Annuity Museum's offices are located at 8 Talmadge Drive, Monroe Township, New Jersey 08831 (USA). All original documents and artifacts exhibited are owned by the Annuity Museum and are available for viewing by appointment only. To schedule a visit, call 732-521-5110 (USA, Eastern time zone).
[3] 1st quarter 2006 edition of Personal Finance magazine