Annuities: Types, Payout Options, Variable Products, and Suitability
Parties and phases
An annuity has an owner, an annuitant (whose life measures the payout), and a beneficiary. During the accumulation phase the contract builds value tax deferred; during the annuitization (payout) phase it distributes income. An immediate annuity begins payments at once; a deferred annuity accumulates first.
Types
Fixed annuities guarantee a rate and are backed by the insurer's general account. Variable annuities invest in a separate account; the owner bears investment risk, and the product is a security requiring a prospectus and securities registration. Indexed annuities credit interest based on an index with caps, floors, and participation rates. Premiums may be single or flexible. Two-tier annuities pay a lower value on full surrender than on annuitization.
Payout options
Life only produces the largest income but ends at death. Life with period certain guarantees payments for a minimum period; installment/refund life returns the unpaid balance; joint and survivor continues for two lives; fixed period and fixed amount pay a set amount of time or money.
Taxation preview
Each payment is part taxable and part tax-free under the exclusion ratio: investment in the contract divided by expected return. Withdrawals before annuitization are taxed LIFO (gains first) and gains before age 59½ generally face a 10% penalty. A 1035 exchange moves an annuity or life policy tax free.
Suitability and traps
Surrender charges, market value adjustments, and free-withdrawal provisions (often 10%) matter. Annuity certain pays regardless of death; life contingency pays only while the annuitant lives. Variable annuity questions usually test the dual-license and separate-account concepts, or the LIFO/penalty rules.