Annuities

What Is An Annuity?

Annuities are insurance contracts issued by financial institutions that promise to pay out the invested funds as a future fixed income stream. Annuities are purchased or invested in by investors using monthly payments or lump sum payments . The holding institution will issue a future stream of payments for a specific period of time, or for the rest of the annuitant’s life. Annuities can be used to help people with retirement and reduce the risk that they will outlive their savings.

Annuity: How It Works

Annuities are designed to help people avoid the fear of outliving their money and assets during retirement. Some investors purchase annuities because their assets might not be sufficient to maintain their level of living.

The financial products are available in two forms: immediate and deferred. People of all ages often purchase immediate annuities when they receive a large sum of money in the form of a settlement, lottery winnings, or other lump sum. They want to convert it into future cash flow. Deferred annuities grow on a tax-deferred base and provide the annuitant with a guaranteed income starting at a specified date.

Annuity products fall under the jurisdiction of the Securities and Exchange Commission and the Financial Industry Regulatory Authority. Annuity agents or brokers must hold a life insurance license issued by the state, as well as a securities license if they are selling variable annuities. The commission that these agents or brokers earn is usually based on notional value.

Special Considerations

Annuities have a period of surrender. Annuitants are not allowed to withdraw money during this period, which can last several years. They must pay a surrender fee or charge. If a large event, like a wedding, requires a lot of money, it may be wise to consider whether or not the investor is able to afford annuity payments.

There is also an income rider in contracts that guarantees a fixed income once the annuity kicks-in. Investors should consider two things when evaluating income riders.

Defined Benefit Pensions, and The Social Security both offer lifetime guaranteed annuities. They pay retirees steady cash flows until their death.

Most insurance companies allow their customers to withdraw 10% of the account value, without having to pay a surrender charge. If you withdraw more, you could end up paying a fee, even though the surrender period is already over. Withdrawals made before the age of 59-and-a-half can also have tax implications.

Some annuitants who are in financial difficulty may choose to sell their annuity payment instead. It is the same as borrowing against another income stream. The annuitant gets a lump-sum and gives up some or all of their future payments in exchange.

Annuities are a hedge against risk of longevity. As long as the buyer understands they are exchanging a lump sum of liquid cash for a series of guaranteed cash flows, then the product is suitable. Annuities are not intended to be cashed out at a future profit.

Annuities Types

Annuities can be designed according to many details and factors. For example, the length of time payments can be guaranteed. Annuities are designed to continue payments as long as the annuitant (or spouse, if survivor benefit has been selected) or spouse is alive. Annuities can also be designed to pay funds for a set period of time (such as 20 years) regardless of the life expectancy of the annuitant.

Immediate Annuities And Deferred Annuities

Annuities can start immediately after a lump-sum deposit, or as deferred payments. immediate annuity pays out immediately after annuitant deposits lump sum.

Deferred Income Annuities, on the contrary, do not begin paying after the initial investment. The client instead specifies the age when they want to start receiving payments from the insurer.

The annuity will recover some or all of the principal in your account depending on which type you select. If you choose a lifetime payout with no refund, the payments will continue until the beneficiary passes away. The recipient of an annuity that is fixed for a certain period of time may be entitled to receive a refund if any principal remains. Or their heirs if the annuitant died.

Deferred Annuity

Deferred annuities are better defined as a group of annuities than a specific type. All annuities are either immediate or deferred. An annuity’s category is determined by when the income payments will begin. The deferred category includes many types of annuities.

The deferred income annuity is divided into two phases. During the accumulation phase, your money is tax-deferred, until you decide to withdraw it in a lump-sum or a series. You choose when you want to withdraw income from your annuity, and pay any taxes due. Deferred annuities give you greater control over taxes.

The longer you defer the payment of income tax, on your compounded earnings, the more you will gain compared to a fully-taxable account such as a certificate of deposit or money market account.

Fixed Annuity

An annuity that pays an annual interest rate is called a Traditional Fixed Annuity. Occasionally, the insurance company will give an initial premium bonus or increase in interest rate during the first year. The issuing insurer will adjust the interest rate annually after the first year. You are guaranteed at least to receive the contractually-guaranteed minimum interest rate in all years.
Traditional fixed annuities receive special tax treatment, just like all other annuities. Annuities are taxed deferred. This means that you don’t pay tax until the money is withdrawn. You can choose to withdraw partial amounts, cash out your annuity and surrender it, or convert your delayed annuity in a stream income payments. When you take the income from your annuity, and therefore when to pay taxes, is up to you. An annuity can give you greater control over your income tax.
Single-year fixed annuities can be referred to as traditional fixed annuities. We call them “trust-me” annuities at AnnuityAdvantage because they are essentially saying, “Give us your money, and after the first, trust us that we will be fair to you.”
You can find out if an insurer has treated their policyholders fairly by asking to see the history of renewal rates. This table will give you an indication of whether the company is a habitual raiser, lower or maintainer of the base interest rates on their previous contracts. This information is not available from all companies.
A traditional fixed annuity’s annual interest rate adjustment is a selling point. When interest rates rise, the contract crediting rate will also increase. With a multi-year guaranteed annuity your interest rate remains the same for a long period, preventing you from taking advantage of any higher rates.
In a rising rate environment, it is unfortunate that most traditional fixed annuity contract holders do not see the crediting rates increase as fast as they had hoped. Some annuity providers are better than others at offering competitive renewal rates. Other issuers might only offer a renewal rate barely above the contractually-guaranteed minimum.
Insurance companies are held accountable for their renewal rates by the competitive market. The renewal rate on a traditional fixed annuity may be too low compared to the current interest rates on new products. Policyholders might then surrender their contracts to move their money into a higher yielding alternative annuity. Insurance companies don’t want this to happen so they will try to offer a rate of renewal that is high enough to retain money and business. Remember that withdrawals before the end of surrender period may be subject to charges.
What’s the bottom-line? If you choose a product that is well-designed and comes from a company with a proven track record of crediting fair interest rates, it may be a good purchase for your needs. If you want a product that offers a fixed interest rate with more certainty, then you might consider Multi-Year Guarantee Annuity.

Payment Phase

When you decide to withdraw income from your annuity, the payout phase begins. This is usually during retirement. You can choose to take partial withdrawals or cash out (surrender your annuity) according to your requirements. Or, you can convert your deferred income annuity (annuitization) into a guaranteed stream of payments. This option is similar to buying an immediate income annuity. It will be automatically triggered on the maturity date if you do not take any action in advance.

Maturity Date

The maturity date of a contract is often confused with the duration of the guarantee or the surrender penalty. The maturity date is the specified date within the annuity agreement at which the owner can elect to settle the contract and start receiving payments. The maturity date is a predefined age that occurs between 95 and 115. The guarantee period, or surrender penalty term, is the period of time in which a contract can still be subject to penalties if it is canceled or refunded before the expiration date. This is usually 3-10 years after the original contract issue date. After 25 years the account with the deferred tax balance is worth $63,220 more than the account that has been fully taxed.

Safety

Annuities deferred tax fixed are secure. These annuities are issued by legal reserve insurance companies that are highly regulated, and are required to fulfill contractual obligations with all policyholders. Legal reserve is the term used to describe the financial requirements an insurance company must meet to protect money paid by policyholders. The reserves must always be equal to the withdrawal amount (principal and interest, less any early withdrawal fees if applicable) for every annuity contract that the company has sold. State insurance laws require life insurance companies to maintain minimum capital and surplus levels, providing additional protection for policyholders.

MYGA

Multi-Year Annuities, also known as Fixed-Rate Annuities or CD-type Annuities, provide a contractually guaranteed and predetermined interest rate over a specified period of time. This is typically between 3-10 years. After 25 years the account with the deferred tax balance is worth $63,220 more than the account that has been fully taxed.

Fixed Index Annuities

Fixed index annuities (formerly equity indexed) are a type of deferred annuity which credits interest based upon changes in a market indicator, such as S&P 500, Dow Jones Industrial Average, or the Dow Jones Industrial Average. The index increases in value, and interest is credited. However, the rate of interest is guaranteed to never be lower than zero even if the stock market falls. You will never lose your principal or any interest earned previously.

This short video provides an overview of indexed annuities, and explains how they can be used to avoid market volatility. They also have a positive effect on your retirement savings.

Insurance companies use different formulas depending on how an annuity is designed to determine the correlation between changes in the index and the amount of interest credited to each annuity at the end of the index term. (Most commonly, this is done on an annual basis). The formula usually has two parts: the crediting method, and a limiting element.

Crediting Methods Frequently Used

Annual Point-to Point
Measures the percentage difference in the index value underlying the contract between two dates – at the start and end of the annuity year.
Multi-Year point-to-point
Measures the percentage difference in the index value between dates more than one-year apart.
Monthly Point-toPoint
Measures the percentage change of the index value every month. Positive changes are usually limited to a monthly cap, but negative changes are not. All monthly percentage changes, both positive and negative, are added at the end of every index term.
Monthly Averaging
Calculated by comparing a given index’s value at the beginning of an index term with its average monthly value at the end. The monthly average index is equal to the sum of all monthly index values over the previous index term divided by the number months. The ending monthly index value for each index term is compared to the index value at the beginning of the term.
Daily Averaging
Calculated by comparing an index’s value at the beginning of its index term with the index’s daily average at the end (usually 252 trading day). The daily average index is equal to the sum of all the daily index values that were recorded on each trading day during the index term preceding it, divided by the total number of trading sessions in the term. The ending daily index value for each index term is compared to the index value at the beginning of the term.

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Common Limiting Factors

In all fixed index annuity crediting formulas, a limiting factor is used to limit the interest earnings to a fraction of the changes in the index during the index term. You will not get 100% of index gains in exchange for additional guarantees and principal protection.

Cap Rate: A maximum interest rate linked to an index that can be applied to an annuity. The cap rate is a maximum interest rate that the annuity may earn during the index period.

Index-Linked Interest Credits are calculated by calculating the percentage increase of the index linked interest credit based on the underlying index.

Spread rate or margin – A percentage deducted from total calculated changes in the index value underlying the annuity to determine the amount of index linked interest credited.

Indexed Annuities provide growth, income for life, and long-term care funding. We can assist you in achieving your indexed annuity goals. We have access to over 30 companies and can run a customized proposal for you based on what you need.

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