Annuities and Retirement Products
Annuities are often described as the mirror image of life insurance: they liquidate an estate. Learn the three parties - the owner controls the contract, the annuitant is the life the payout is measured on, and the beneficiary receives any remainder. The owner and annuitant are often, but not always, the same person, and the annuitant's death can trigger payout even while the owner lives.
Types
Immediate (pays within one payment period) versus deferred (accumulation phase first). Fixed (guaranteed rate, insurer bears investment risk), variable (separate account, prospectus and securities license, owner bears risk), indexed (index-linked interest with a cap, participation rate and floor), and market value adjusted. Single versus flexible premium.
Payout options
Life only (highest payment), life with period certain, installment refund, cash refund, joint and survivor, fixed period, fixed amount.
Taxation
The exclusion ratio sets the tax-free share of each annuitized payment: investment in the contract divided by expected return. Nonqualified annuities use after-tax dollars, grow tax deferred, and gains are taxed as ordinary income when withdrawn, generally first-in-last-out, with a 10% penalty before age 59½ subject to exceptions. A 1035 exchange moves the contract without current tax. Surrender charges apply during the surrender period; many contracts allow a free withdrawal allowance.
Trap: nonqualified annuities have no contribution limit but are never deductible, and annuitizing does not by itself create a taxable event for the already-taxed basis.
Worked example: basis $50,000, expected return $200,000 → 25% exclusion. On a $1,000 payment, $250 is tax free and $750 is taxable.