Annuities
Provisions, Options and Riders
Core contract provisions
- Entire contract - the policy plus the application constitute the agreement; only an authorized officer may change it.
- Free look - typically 10 days after delivery to return for a full refund.
- Grace period - commonly 30 or 31 days after the due date; the policy stays in force, and unpaid premium may be deducted from the claim.
- Incontestability - after two years the insurer cannot void for misrepresentation (nonpayment of premium is always contestable).
- Suicide clause - typically two years; the insurer refunds premiums rather than paying the face amount.
- Misstatement of age or sex - the benefit is adjusted to what the premium would have purchased, not voided.
- Reinstatement - usually within 3–5 years with evidence of insurability and payment of overdue premiums plus interest.
Ownership features
Policy loans accrue interest, reduce the death benefit, and can lapse a policy; the automatic premium loan uses cash value to pay premiums. Nonforfeiture options apply to permanent insurance: cash surrender, reduced paid-up, extended term. Dividend options: cash, reduce premium, accumulate at interest, paid-up additions, one-year term.
Settlement options
Lump sum, interest only, fixed period, fixed amount, and life income (straight life, life with period certain, joint and survivor, refund/installment refund).
Riders
Waiver of premium, disability income, accidental death and dismemberment, guaranteed insurability, cost-of-living, long-term care, child term, return of premium, accelerated death benefit, and term conversion.
Traps
Dividends are not guaranteed and are a return of premium; they become taxable only after cost basis is exceeded. A policy loan is not taxable unless the policy lapses.
Rule of thumb
Remember the 2-2-3 windows: two years to contest, two years for suicide, three to five years to reinstate.
Annuities
What an annuity is
An annuity is the opposite of life insurance: it liquidates an estate rather than creating one, protecting against the risk of living too long. Know the parties: owner (controls the contract, pays premiums, names the beneficiary), annuitant (whose life measures the payout), beneficiary, and insurer. The owner and annuitant are often, but not always, the same person.
Two phases
During accumulation the contract builds value; during annuitization it converts to a stream of income. Immediate annuities begin payouts within one payment period; deferred annuities accumulate first.
Types
- Fixed - guaranteed interest rate; insurer bears investment risk.
- Variable - separate account subaccounts; owner bears investment risk; treated as a security (prospectus, securities registration, FINRA-licensed representative).
- Equity-indexed - credited by an index with cap, floor, and participation rate.
Payout options
Straight life (highest payment, ends at death), life with period certain, joint and survivor, and refund/installment refund options.
Taxation
Nonqualified annuities use the exclusion ratio: investment in the contract ÷ expected return = tax-free portion of each payment. Pre-annuitization withdrawals are taxed gains-first (LIFO), with a 10% penalty before age 59½ (exceptions include death, disability, and annuitization). Qualified annuities such as IRAs have no basis, so everything is taxable. 1035 exchanges move annuity values tax-free between contracts. Surrender charges and market value adjustments can apply early.
Traps
Annuities are not life insurance and pay no death benefit after annuitization begins. A variable annuity is always a security. Bonus annuities often carry longer surrender schedules.
Worked example
$100,000 basis ÷ $200,000 expected return = 50%. On a $1,000 monthly payment, $500 is excluded from income and $500 is taxable until basis is fully recovered.