Annuities
Mechanics
An annuity pays an income the annuitant cannot outlive, protecting against longevity risk. Two phases: accumulation (payments in, growth tax-deferred) and annuitization or payout (income out). The annuitant's life measures the payout, the owner controls the contract, and the beneficiary receives any survivor benefit.
Types
Immediate (income begins within one payment period) vs deferred. Single premium vs flexible premium. Fixed (declared interest with a guaranteed minimum; insurer bears investment risk) vs variable (separate accounts, securities license and prospectus required, no guaranteed return) vs indexed (credits tied to an index with caps, participation rates, and floors). A market value adjustment can reduce surrender value on fixed deferred contracts when rates rise. Surrender charges typically decline over 5–10 years, and a free withdrawal amount is usually available each year.
Payout options
Life only (highest income, nothing to survivors), life with period certain, installment/refund life, joint and survivor, fixed period, and fixed amount. Once annuitized, the election is generally irrevocable.
Taxation
Nonqualified annuities are funded with after-tax dollars; the exclusion ratio makes part of each payment a tax-free return of basis until basis is recovered, after which payments are fully taxable. Before annuitization, withdrawals are LIFO (gain first) with a 10% penalty before 59½, subject to exceptions. Death proceeds are taxable to the beneficiary to the extent of gain. Qualified annuities (IRA, 403(b)) generally have no basis. Section 1035 exchanges move funds tax-free between like contracts.
Suitability
Sales require a suitability/best-interest review, disclosure of surrender charges and bonus recapture, and a free look of at least 10 days in Alaska.
Trap: a variable annuity's separate account is not guaranteed, and 1035 cannot exchange an annuity into a life policy.