Annuities
The mechanics
An annuity is a contract that liquidates a sum of money over time, protecting against the risk of living too long (longevity risk). The owner pays premiums, the annuitant is the measuring life, and the beneficiary receives any death benefit. Two phases: accumulation (payments in, values grow) and annuitization payout (funds convert to income).
Classifications
Immediate vs deferred; single premium vs flexible premium; fixed (guaranteed interest, general account, insurer bears risk), variable (separate account, owner bears investment risk, sold as a security), and indexed (credited by index formula with cap, participation rate, and floor). Qualified annuities sit inside IRAs or retirement plans with pre-tax money; nonqualified are funded with after-tax dollars.
Payout options
Life only pays the highest income but nothing after death; life with a period certain or installment refund guarantees a minimum payout; joint and survivor continues to a second annuitant; fixed period and fixed amount liquidate a stated sum. Choosing an income option is generally irrevocable.
Costs and consumer protections
Surrender charges apply to early withdrawals, typically declining over 7 to 10 years; there may be a free withdrawal band (often 10%). Market value adjustments apply to some fixed contracts. A 1035 exchange may move a life policy into an annuity or annuity to annuity tax-free, but annuity to life is not permitted. Suitability and best-interest standards require documenting the client's needs, and variable annuities require both a state insurance license and FINRA registration.
Trap: life-only annuities are not 'bad' - they are the purest longevity hedge. Also, an annuitant's death does not always trigger a death benefit; check who is the owner/beneficiary.
Rule of thumb: deferred annuity for accumulation plus tax deferral; immediate for income now.