Annuities
Structure and purpose
An annuity is the mirror image of life insurance: it liquidates an estate by paying a stream of income, protecting against longevity risk. The accumulation period builds value; the annuity period pays it out. Immediate annuities begin payouts within about a year of purchase; deferred annuities accumulate first. Fixed annuities guarantee a rate; variable annuities invest in separate-account subaccounts (registered as securities - a producer needs both a state insurance license and FINRA registration); indexed annuities credit interest based on an index subject to a floor and cap/participation rate.
Payout options
Straight life (life only) pays the highest income but ends at death with nothing to heirs. Life with period certain guarantees payments for a minimum number of years. Joint and survivor continues to the second annuitant, usually at a reduced amount. Period certain and amount certain pay for a fixed time or fixed payment without life contingencies. Annuitization is generally irrevocable. Payments received are part taxable, part tax-free under the exclusion ratio for nonqualified contracts (investment in the contract ÷ expected return), until basis is recovered. Qualified annuities (IRA, 401(k)) have no basis recovery - everything is ordinary income. Withdrawals before age 59½ generally trigger a 10% federal penalty plus income tax; surrender charges may also apply early.
Traps
Variable annuities require securities registration; fixed do not. Annuity death benefits and accumulation are tax-deferred, not tax-free. Free-look periods (commonly 10 days; longer on replacement in some states) apply, and suitability rules matter for seniors and replacements. Do not confuse annuity accumulation units with annuity units after annuitization.
Rule of thumb
Longer guarantees and survivor benefits lower each payment; life-only pays the most.
Worked example: A $60,000 nonqualified investment is expected to return $120,000. Exclusion ratio = 60,000 ÷ 120,000 = 50%, so half of each payment is tax-free until basis is recovered.