Annuities and Retirement Products
Nature of annuities
An annuity is the mirror image of life insurance: it liquidates an estate rather than creating one and transfers longevity risk to the insurer. The contract has an accumulation phase and a payout (annuitization) phase, and annuitization is generally irrevocable. Fixed annuities guarantee a rate; variable annuities invest in a separate account and are securities (registration, prospectus, and securities license required), using accumulation units converted into annuity units; indexed annuities credit interest by an index subject to a cap, participation rate, and floor.
Payout options
Life only (largest payment, no refund), life with period certain, installment/refund, joint and survivor, fixed period, and fixed amount. An immediate annuity begins payments within one payment period; a deferred annuity waits.
Taxation
Use the exclusion ratio: investment in the contract divided by expected return equals the tax-free fraction of each payment. Nonqualified withdrawals before annuitization are LIFO - gains first - and may face a 10% penalty before age 59½. Qualified plans (IRA, 401(k), 403(b), SEP) provide deferral or deduction and tax ordinary income at distribution, with required minimum distributions beginning at age 73. A 1035 exchange moves annuity or life values tax-free.
Consumer protection
Suitability and best-interest reviews examine liquidity needs, surrender charges, replacement of an existing contract, time horizon, and source of funds.
Worked example: a $100,000 premium with an expected return of $120,000 gives an exclusion ratio of 100,000 ÷ 120,000 = 83.3%. On a $500 monthly payment, about $416.67 is excluded from income and $83.33 is taxable until basis is recovered; afterwards the whole payment is taxable.
Traps: annuity death benefits avoid probate only when a beneficiary is named; "a variable annuity is not a security" is false; "indexed annuity gains are unlimited" is false.