Annuities and Retirement Products
The two phases
An annuity is a contract that liquidates a sum of money over time. In the accumulation phase the contract builds value (fixed interest, separate-account investments, or indexed credits); in the annuitization (payout) phase the insurer makes periodic payments. The owner controls the contract; the annuitant is the measuring life; the beneficiary receives any death benefit. Confusing owner and annuitant is a classic exam trap.
Types
Immediate vs. deferred; fixed (guaranteed interest) vs. variable (separate account, securities license required) vs. indexed (credited by an external index with caps, participation rates, and floors). Qualified (IRA, 403(b)) vs. nonqualified (after-tax) contracts differ in taxation.
Payout and taxation
Payout options: life only (highest income, no refund), life with period certain, joint and survivor, fixed period, fixed amount. On a nonqualified annuity, each payment is part principal (tax-free) and part interest (taxable) under the exclusion ratio. Withdrawals before age 59½ generally incur a 10% federal penalty on the taxable portion, and gains are taxed LIFO on surrender. Surrender charges and market value adjustments may apply early; many contracts allow a free withdrawal corridor.
Exchanges and suitability
A 1035 exchange moves an annuity or life policy tax-free. Suitability/best-interest rules require documenting the client's needs, liquidity, time horizon, and whether a replacement benefits them.
Worked example
A 62-year-old invests $100,000 nonqualified; the exclusion ratio determines how much of each $600 monthly check is tax-free return of basis. If she instead withdraws $10,000 at 58, gains come out first and are taxed plus penalized.
Traps
Annuity vs. life insurance; annuitization vs. surrender; variable products needing a securities license; and confusing qualified (fully taxable) with nonqualified (exclusion ratio) taxation.