Annuities and Retirement Products
Mechanics
An annuity liquidates a sum of money over time and protects against longevity risk. Deferred annuities have accumulation and annuitization phases; immediate annuities begin payments within one payment period. Fixed annuities guarantee a rate; indexed annuities credit interest by an index formula with caps and floors; variable annuities invest in separate-account subaccounts, shift investment risk to the owner, and require a securities license and prospectus.
Payout options
Life only pays the most and refunds nothing. Life with period certain guarantees a minimum number of payments; installment refund returns the unpaid balance to a beneficiary; joint and survivor continues for a spouse. Every guarantee added reduces each payment.
Accumulation versus annuity units
In a variable annuity, values accumulate in accumulation units; at annuitization they convert to annuity units, whose number is fixed while their value fluctuates.
Taxation
Annuity earnings grow tax-deferred. A nonqualified payout uses the exclusion ratio, the investment in the contract divided by expected return, so part of each payment is a tax-free return of basis. Withdrawals before annuitization are taxed last-in, first-out (gain first) and generally carry a 10 percent penalty before age 59 and a half. Qualified annuities funded with pre-tax dollars are fully taxable.
Traps
Annuities are not life insurance and pay no death benefit unless a guarantee or rider applies. Surrender charges offset early withdrawals. Replacing a policy triggers Regulation 60 disclosure, and sales must meet Regulation 187 best-interest standards.
Worked rule
Cost of the guarantee: life only pays the most, life with 10-year certain pays less, installment refund pays least. The more protection for heirs, the smaller the check.