Annuities

What an Annuity Is: The Two Phases

An annuity — sold only by life insurers — guarantees income the annuitant cannot outlive. It runs in two phases: the accumulation period, where premiums grow tax-deferred and the owner holds all rights (it ends at death, payout, or surrender — never because a premium was skipped), and the annuity period, where the insurer takes the fund and pays income of principal plus interest. The switch between them — annuitization — is irrevocable. Like life insurance, it's mortality-based risk sharing: die early and the insurer wins; live long and you win.

The Four Parties

Four parties: the insurer, the contract owner (buys, pays, controls — annuitization timing, beneficiary changes, distributions, transfers), the annuitant (receives the income, and whose life expectancy — never the owner's — the payments are based on), and the beneficiary (collects contributions plus interest if the owner dies during accumulation; if nobody is named, the owner's estate collects). Owner and annuitant can be the same person or different people.

Classification by Premium: Single, Level, Flexible

A single premium annuity is fully funded with one lump sum — principal exists immediately, no further deposits — and comes in two flavors: SPIA (income ~30 days later) and SPDA (income later, sometimes with a bailout provision for penalty-free exit if rates drop). Periodic-premium contracts are either level premium (fixed payments; an older, high-front-load design) or the flexible premium deferred annuity — vary or skip payments, income based on the total saved — which is today's best-seller: minimal front-end loads, but back-end surrender charges.

Immediate vs Deferred

An immediate annuity (SPIA) starts paying as soon as 30 days after purchase and no later than 12 months; single premium only, so there's no accumulation period — ideal for a new retiree or a disabled person needing income now. A deferred annuity starts more than a year out, accepts any premium plan, and emphasizes safe, tax-deferred accumulation. At payout time the owner picks one of three exits: lump sum (credited interest taxable), systematic withdrawals, or irrevocable annuitization.

Fixed, Variable, Indexed & MVA

The risk question decides everything. A fixed annuity: general account, insurer bears the risk, guaranteed minimum rate — but most vulnerable to inflation. A variable annuity: separate account (creditor-protected in insolvency, SEC-registered under the Investment Company Act of 1940, divided into mutual-fund-like subaccounts), owner bears the risk, sold only with a life license plus Series 6/7 and a prospectus. Pay-in buys accumulation units; annuitization converts them to a fixed number of annuity units with a fluctuating value. In between sit the equity-indexed annuity — a FIXED product crediting a participation-rate slice of an index's gain, principal protected — and the market value-adjusted annuity, which locks a rate for 2–10 years but docks early surrenders with an MVA plus a surrender charge.

Payout Options & Number of Lives

The trade is always guarantees vs check size. Straight life: income for life, nothing to survivors, highest payment. Annuity (period) certain: a fixed period only — payments stop at the period's end even if alive; die early and the beneficiary finishes the period. Life with period-certain: life OR the period, whichever is longer. Life with refund: the whole principal is guaranteed to be paid — installment refund continues the checks, cash refund pays a lump sum. On multiple lives: joint life stops at the FIRST death; joint and survivor pays until the LAST death.

Surrender Charges, Non-Forfeiture & Living Benefit Riders

Surrender charges (back-end loads) hit withdrawals beyond the free corridor (typically 10%/year), decline annually until waived, and are excused for death, disability, or skilled-nursing care — and they're separate from the IRS's 10% penalty, so both can apply at once. The non-forfeiture value before annuitization is premiums + interest − withdrawals − charges. Variable contracts can add living-benefit riders: GMWB (withdraw 5–10%/yr of the initial investment regardless of markets), GMIB (minimum income at annuitization — annuitizing is required), and GMAB (minimum accumulation value after a waiting period — no annuitization needed).

Uses & Suitability

For tax purposes an annuity is qualified or non-qualified — deductible contributions inside a qualified plan vs after-tax dollars outside — but growth is tax-deferred either way. Beyond retirement income, annuities fund IRAs, Keoghs, SEPs, 401(k)s, education savings, and structured settlements for lawsuits and lottery wins. The tax-sheltered annuity (403(b)/501(c)(3)) serves employees of non-profits, schools, and churches with salary-reduction contributions excluded from current income. Every recommendation must clear suitability: a reasonable inquiry into age, income, needs, experience, objectives, time horizon, liquidity, and risk tolerance — with extra standards for senior consumers (65+, or any party 65+ in a joint purchase).

Annuity Taxation

Money coming out follows four rules. (1) Annuitized payments split via the exclusion ratio (investment ÷ expected return): the principal slice is tax-free, the growth slice is ordinary income. (2) Early withdrawals are LIFO — earnings first, plus a 10% penalty before 59½ (exceptions: death, disability, 59½+, immediate annuity, qualified plan). (3) Death during accumulation pays the beneficiary the greater of value or contributions — and the gain is TAXABLE, unlike life insurance proceeds; a life-income election within 60 days spreads the tax. (4) 1035 exchanges run one way: annuity→annuity and life→annuity are tax-free, annuity→life never is. Corporate owners must respect the non-natural person rule: name a human annuitant or lose the tax deferral.