Annuities
Structure
An annuity liquidates an accumulated sum over time. Two phases: accumulation, then annuitization (payout). Annuities are classified by when income starts (immediate versus deferred), by how premiums are paid (single versus flexible), and by how value grows (fixed, variable, indexed).
Fixed and variable
A fixed annuity guarantees a rate and pays a fixed dollar benefit; the insurer bears investment risk. A variable annuity tracks separate-account subaccounts; the owner bears investment risk and holds accumulation units that convert to annuity units at annuitization. Variable annuities require a securities license.
Payout options
Life only pays the most but ends at death. Life with period certain, installment refund, and joint and survivor each trade a smaller payment for a guarantee. The exclusion ratio determines the tax-free portion of each payment: investment in the contract divided by expected return.
Taxation and rules
Interest accumulates tax-deferred, and withdrawals before annuitization are generally taxed gains-first. Withdrawals before age 59 1/2 may trigger a 10 percent federal penalty. Required minimum distributions apply to qualified annuities, generally beginning at age 73. Surrender charges and market value adjustments apply in early years, and most contracts allow some free withdrawal.
Traps
Do not confuse accumulation units with annuity units. In a deferred annuity the death benefit is generally at least the accumulation value. Qualification matters: nonqualified money carries basis, qualified money is largely taxable.
Rule of thumb: immediate means payments begin within one payment period; deferred means later.