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Annuities Explained

What is an annuity?

An annuity is a contract between an insurance company, contract owner, and annuitant.
The beneficiary (listed on the beneficiary form) inherits the remainder after the death of the owner/annuitant. Depending on the type of annuity will determine if it starts either in the payout or accumulation
(deferral) phase. Here are the four types of annuities:

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Immediate Annuity

Immediate annuities are purchased with a single premium and typically start in the payout phase, meaning funds are being paid out of the contract. The most common type of immediate annuity begins within 30 days but can go as long as 1 year.

A deferred immediate annuity usually starts payments after 1 year and can be as long as 30 years. An example of a deferred immediate annuity is a Qualified Longevity Annuity Contract (QLAC), which is purchased to delay Required Minimum Distributions (RMDs) up to age 85 on a portion of an individual’s IRA.

With immediate annuities, the payout options to choose from include:

  • Single Life: One life is insured
  • Joint Life: Two lives are insured
  • Period Certain: Payments for a specific number of years
  • Refund: Balance paid to beneficiary (clause added to Single or Joint Life)

Immediate annuities have the least amount of control and can’t be surrendered. The only option is to sell on the secondary market (partial or full amount).

Fixed Annuity

Fixed annuities are purchased either with a single or flexible premium and typically start in the accumulation phase, meaning funds are being deferred in the contract.

With fixed annuities, the styles to choose from include:

  • Traditional: Initial interest rate followed by a renewal rate declared by the insurance company
  • Multi-Year Guaranteed Annuity (MYGA): Similar to a bank CD and interest rate is guaranteed for the period of time
  • Long-Term Care Annuity: Specifically designed annuity for long-term care with benefits ranging from 2-4.5 times the initial deposit

Contracts can be structured for a shorter (e.g. 1-2-years) or longer period of time (e.g. 3-15 years).

Index Annuity

Indexed annuities are a byproduct of fixed annuities and often referred to as “fixed indexed annuities,” purchased either with a single or flexible premium. They typically start in the accumulation phase, meaning funds are being deferred in the contract. Each insurance company has their own crediting methods and indices, but the usual one is the S&P 500. Some might offer proprietary indices illustrated through “back-testing,” where the index might be relatively new. Although particular ones have the ability to grow, not all insurance companies are alike.

With indexed annuities, the crediting options include:

  • Annual Rest: Compares the change of the index at closing end of the term to the closing value on the first day of the term.
  • Monthly Average: Compares index value on the first contract day of the month to the monthly average of the contract day of the following month.
  • Monthly Sum: Compares percentage increase or decrease in index value each month and adds them up.

Additional features include guaranteed lifetime income, death benefit riders, and chronic illness “doublers” for a fee. Depending on the insurance company, contracts can be structured for a shorter term (e.g. 6 years or less) but typically are about 10 years. Many insurance companies don’t charge a fee for the basic contract but some do.

Variable Annuity

Variable annuities are purchased either with a single or flexible premium and typically start in the accumulation phase, meaning funds are being deferred in the contract.

It is the only type of annuity that is risky to the owner/annuitant, with the principal worth possibly less than the initial deposit. Depending on the insurance company, most are invested in mutual fund subaccount options provided through a prospectus.

With variable annuities, the styles to choose from include:

  • Traditional: Owner/annuitant assumes entire risk but obtains all reward through mutual fund subaccounts
  • Buffer: Owner/annuitant is capped on the earning potential while being limited on the losses

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Annuity Myths and Realities Myth: Annuities are complicated. Reality: Although indexed annuities have different crediting methods, with the correct anniversary dates and math formula they can be solved. Variable annuities typically use mutual fund subaccounts that can be tracked. Fixed annuities–particularly MYGAs–are the easiest to decipher since it’s an interest rate for a set period of time (similar to a bank CD). Annuities with income riders work like a pension or Social Security income, which can guarantee you a lifetime stream of income. …..

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Mistakes to Avoid with Annuities Mistake: Assuming all annuities are the same. Annuities issued by different insurance companies and all operate differently. Always read the contract or prospectus, and if you don’t understand how the contract works, don’t buy it. Mistake: No beneficiary or naming the estate as beneficiary. When no individual is named as beneficiary or the estate is the named beneficiary, the annuity proceeds go to the owner’s estate. This would subject the annuity to probate and distribute according to your will or under state law. An important reason people purchase annuities is to avoid the probate process, so a beneficiary designation is intended to bypass probate. However, if no beneficiary exists, the proceeds go to the estate and distributed accordingly. …..

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Reasons to Purchase an Annuity You can’t lose the money you used to purchase the annuity. Besides surrender charges, principal protection means you will always walk away with your contract value no matter what. While this is true with immediate, fixed, indexed, and long-term care annuities, variable annuities don’t offer this guarantee. This is the reason why it’s important to choose the right one or you might otherwise suffer potential consequences. …..


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