Annuities, Retirement and Tax-Related Products
Annuities
How annuities work
An annuity is a contract that accumulates money and then pays an income, usually for retirement. During accumulation, premiums earn interest or investment returns; during annuitization, the insurer pays benefits according to the payout option. Immediate annuities begin income soon after purchase; deferred annuities accumulate first. Fixed annuities guarantee a rate; indexed annuities tie credits to an index with caps and floors; variable annuities invest in separate accounts and shift investment risk to the owner.
Payouts and taxation
Payout options include straight life, life with period certain, joint and survivor, fixed period, and fixed amount. Straight life pays the most because payments stop at death. Annuity income is taxed using the exclusion ratio: the investment portion is excluded, and the earnings portion is taxable. Surrender charges may apply early, and annuitization is generally irrevocable.
Traps
A variable annuity generally requires a securities license. An annuity is not life insurance, though both may receive favorable tax treatment. Do not say a deferred annuity avoids probate automatically. Suitability, replacement, and surrender charge disclosure matter.
Rule of thumb
If the client needs guaranteed lifetime income and wants the largest payment, straight life is the benchmark; adding period certain or survivor benefits reduces the payment.
Retirement and Tax-Related Products
Qualified versus nonqualified
Qualified plans meet tax-code requirements and receive tax deferral, and employer contributions may be deductible. Common plans include 401(k), 403(b), defined benefit, defined contribution, SEP, SIMPLE, and Keogh plans. IRAs and Roth IRAs are individually arranged; traditional IRA contributions may be deductible, while Roth contributions are after-tax and qualified withdrawals are tax-free. Vesting determines ownership of employer contributions. Required minimum distributions apply to traditional tax-deferred accounts after the required beginning age.
Tax rules candidates must know
Life insurance death proceeds are generally income-tax-free to the beneficiary, but estate tax may apply if the insured owns the policy. Policy loans are not taxable while the policy remains in force, but lapse or surrender can create taxable gain. A 1035 exchange can move life insurance to life insurance or an annuity, or annuity to annuity, without current tax. A modified endowment contract loses some life-insurance tax advantages. Early withdrawals from IRAs and qualified plans may incur a 10% penalty plus ordinary income tax, with exceptions.
Traps
Do not say all IRA contributions are deductible or that Roth withdrawals are always tax-free. A 1035 exchange is not unlimited. MEC rules are based on funding relative to the death benefit.
Rule of thumb
Ask whether the money went in before tax or after tax; that determines whether withdrawals are taxable.