Annuities

Question 1

accumulation period

Answer 1

a period of time in which interest is credited to an annuity on a tax-deferred basis

Question 2

Annuity

Answer 2

a long-term contractual arrangement in which an investor gives money to an insurance company and is expected to get it back with interest in either a lump sum or a series of regularly scheduled payments.

Example:
Ten years ago, Joon decided to invest in an annuity, putting in $150,000. Fast forward a decade, and thanks to growth over time, that annuity is now worth $175,000.

Now that Joon is ready to retire, they can start receiving monthly income from the annuity. That $175,000 doesn’t just sit there: It gets converted into a steady stream of payments that will continue for as long as Joon lives.

Question 3

deferred annuity

Answer 3

works well for someone who doesn’t need additional income immediately but anticipates needing it in the future. These annuities typically undergo an accumulation period lasting several years, during which their value grows on a tax-deferred basis. At a later date, the owner has options to either convert the annuity to an income stream or exchange it for another annuity.

Think of a deferred annuity as a financial slow cooker: Set it up now and enjoy the results later.

Question 4

immediate annuity

Answer 4

(also commonly known as a single-premium immediate annuity or SPIA) begins generating income shortly after purchase, typically within one year. This type of annuity typically involves a one-time payment to the insurer.

Since receiving income from an annuity triggers taxation, immediate annuities offer significantly fewer opportunities for tax deferral compared to their deferred counterparts.

Relatively quick income makes this option more like a microwave than a slow cooker!

Question 5

split annuity

Answer 5

combines the features of both deferred and immediate annuities. With this approach, a portion of the money creates income quickly, while another portion is set aside to accumulate interest on a tax-deferred basis.

Question 6

annuitant

Answer 6

the person whose life expectancy is usually used to determine the size of annuity payouts, also usually the person who receives the payouts

Question 7

The Annuity Owner

Answer 7

The annuity owner is the person who puts money into the annuity. This individual chooses how much to invest and is usually (but not always) the party responsible for paying taxes when the money is received.

Must be a real human

Question 8

The Insurance Company

Answer 8

The insurance company issues the annuity to the owner and has a contractual obligation to eventually pay money to a person or other entity. This contractual obligation is one of the many insurance-related elements of annuities.

Question 9

The Beneficiary

Answer 9

The beneficiary is a person, corporation, or trust that receives death benefits if someone passes away before income payouts from the annuity have begun. Depending on the specific annuity, a beneficiary might also be entitled to benefits even after the insurance company has started making payments from the owner’s account.

Question 10

annuitization

Answer 10

The payout process.

Most annuitized payouts are fixed at equal/level amounts and follow a predetermined schedule, such as monthly payments for life or for a specific number of years. The amount of each payment depends on two key factors: the annuity’s value at the time of annuitization and how long the payments are expected to continue.

Question 11

Common Payout Options: Single life

Answer 11

The annuity provides consistent (level) payments until the person dies. If the individual lives longer than expected, the insurer must continue payments. If death occurs earlier than anticipated, the payments stop. This option is sometimes called straight life.

Question 11

Common Payout Options: Period certain

Answer 11

Payments continue for a predetermined number of years. If the person dies during this period, the remaining payments go to the beneficiary. Once the term ends, payments stop regardless of whether the annuitant or the beneficiary is still alive.

Question 12

Common Payout Options: Life with period certain

Answer 12

Payments continue for either the person’s lifetime OR a set number of years, whichever lasts longer. This option provides protection in case someone dies shortly after choosing to receive a lifetime income.

Question 13

Common Payout Options: Joint life

Answer 13

Payments continue until the first person in a group dies. Married couples often select this option.

Question 14

Common Payout Options: Joint life and survivorship:

Answer 14

Payments continue until all people in the group have died. Married couples frequently choose this option. After the first death, payments can either remain the same or decrease by a percentage.

Question 15

Payout option: single life (striaght life)

Answer 15

the beneficiary typically receives nothing after the annuitant’s death. The income stream ends when the annuitant dies.

Question 16

Payout option: period certain

Answer 16

the beneficiary receives continued payments only if the guaranteed period hasn’t expired. These payments continue until the end of the originally specified period.

Question 17

Payout option: cash refund provision

Answer 17

an annuity option that provides a death benefit equal to the owner’s principal investment minus what was already paid out by the insurer

Question 18

Payout option: installment refund option

Answer 18

similar to a cash refund provision but provides a refund in monthly pieces instead of a lump sum.

Question 19

qualified annuities

Answer 19

annuities purchased with pretax dollars and that will result in payouts being fully taxable. These types of annuities tend to be purchased within qualified retirement plans.

Question 20

Non-qualified annuities

Answer 20

annuities purchased with after-tax dollars, which will make payouts partially taxable

Pros over many retirement plans:

1. They typically don’t limit how much money investors can contribute.
2. The funds can remain untouched indefinitely with no required withdrawals at a certain age.

Most annuities sold today fall into the non-qualified category.

With non-qualified annuities, owners are ultimately taxed only on the growth in their accounts. However, nearly any withdrawal will include some growth and result in taxable income.

Each payout from a non-qualified annuity typically consists of:

1. A non-taxable return of principal 2. taxable amount of interest or growth

Question 21

The Exclusion Ratio

Answer 21

To determine the taxable and non-taxable portions of each payout, we need to know the owner’s principal sum (how much was invested) and the expected total return on the annuity (an estimate of how much will be paid out in total from the annuity by the insurer). By dividing the owner’s principal sum by the expected total return, we arrive at the annuity’s exclusion ratio.

The exclusion ratio is the percentage of each payout that won’t be taxed. This calculation is completed when payouts begin and will apply until the total expected return has been received.

example
Katrina purchased an annuity years ago for $80,000 and is ready to convert it to an income. Based on her annuity’s current value and her remaining life expectancy, the insurance company has determined that she’s likely to receive a total of $90,000 in payouts. Therefore, Katrina’s principal sum is $80,000, and her total expected return is $90,000.

By dividing the principal sum ($80,000) by the total expected return ($90,000), Katrina’s insurer arrives at an exclusion ratio of approximately 89%. This means about 89% of each payout will be non-taxable, while 11% will be taxable income. This ratio applies until Katrina receives the total expected return of $90,000. After that, 100% of each payout becomes fully taxable.

Question 22

When making a one-time withdrawal (not creating regular income), all taxable growth comes out first. This is a concept known as last in, first out. (Read example on back)

Answer 22

Joe invested $10,000 in an annuity that has grown to $12,000. If Joe makes a withdrawal for emergency expenses without converting to regular income, the first $2,000 withdrawn will be taxable income.

Question 23

Are annuity death benefits tax free?

Answer 23

annuity death benefits usually require beneficiaries to pay taxes on the difference between the annuity’s value and the owner’s original investment.

If an annuity is still in the accumulation period, and if death benefits are about to be paid to a surviving spouse, the annuity can usually be left untouched and allowed to keep growing on a tax-deferred basis.

Question 24

Early Withdrawal Penalty

Answer 24

Annuity tax benefits are designed for retirement. To prove this point, the IRS enforces a 10% penalty on annuity withdrawals that occur before age 59½. This penalty is in addition to regular income taxes that might be owed on the withdrawal. The 10% penalty (but not regular income taxes) can be avoided if: - The owner is at least 59½. - The owner is disabled. - The owner has died, and payments go to a beneficiary. - The owner converts the annuity to regular income rather than making a one-time withdrawal.

Question 25

Taxation on Corporate-owned Annuities

Answer 25

If an annuity is owned by something other than a human (such as a corporation), tax deferral might not be allowed. Instead, the owner can be required to pay taxes on growth within the annuity each year.

Question 26

Surrender Charges

Answer 26

Surrender charges are fees annuity owners pay for taking money out early. They reduce the annuity’s value, are set by the insurance company, and are separate from IRS tax penalties. They usually last about 7 years, starting around 7% and decrease each year. Many insurers permit owners to withdraw up to 10% of the annuity's value annually without incurring surrender charges. This provides some flexibility within the constraints of the contract.

Question 27

crisis waiver

Answer 27

For an additional cost, a crisis waiver can be added as a rider to the contract, allowing the owner to withdraw more than the standard 10% allowance in specific circumstances: Disability Entering a long-term care facility Extended unemployment Other significant life events specified in the contract

Question 28

nonforfeiture value

Answer 28

Many States require annuities to have a minimum guaranteed value if you surrender them early. Even with surrender charges, the owner must receive at least a set percentage of their money back, often around 87.5% of principal plus interest, depending on state law.

Question 29

fixed annuities

Answer 29

Fixed annuities guarantee your principal (original investment) and interest, so your money won’t go down, even in a bad economy. The interest rate may change over time, but it will never drop below the contract’s minimum guarantee. The main downside is that the interest earned may not keep up with inflation. If a fixed annuity isn’t earning enough to beat inflation, someone might want to cash out early. But doing so can trigger a market‑value adjustment, meaning extra penalties may apply if current interest rates are higher than when the annuity was bought.

Question 30

Variable Annuities

Answer 30

Variable annuities don’t guarantee returns and can lose value because the owner chooses the investments. The money is placed in investment options that rise and fall with the market and have more fees. The upside is the potential for higher returns that may keep up with or beat inflation. Variable annuities are both insurance and investment products, so selling them requires insurance and securities licenses. They’re regulated by the SEC and FINRA (Financial Industry Regulatory Authority ) to protect consumers. Every variable annuity must include a prospectus that explains the fees and investment options.

Question 31

A guaranteed minimum income benefit (GMIB)

Answer 31

A GMIB ensures that a variable annuity can be converted to at least a certain amount of income, even if the annuity's value decreases during the accumulation period. Besides paying for this guarantee, the owner usually must keep part of the annuity invested according to the insurer's requirements for a set number of years.

Question 32

A guaranteed minimum accumulation benefit (GMAB)

Answer 32

A GMAB guarantees the annuity will maintain at least a certain value throughout the accumulation period, regardless of market downturns. At minimum, it ensures the annuity won't be worth less than the original investment. This option helps owners who want protection while maintaining the flexibility to avoid converting to regular income.

Question 33

A guaranteed minimum withdrawal benefit (GMWB)

Answer 33

A GMWB guarantees the owner can withdraw at least a certain amount each year during the accumulation period, regardless of market performance. This guarantee continues until the owner has withdrawn an amount equal to the original investment.

Question 34

Indexed Annuities

Answer 34

Indexed annuities combine growth potential with protection from losses. They earn interest based on a stock index’s performance, but the value never goes down if the market drops. You don’t invest directly in stocks, and your principal is guaranteed. Because of these guarantees, indexed annuities are usually treated like fixed annuities and can be sold without a securities license.

Question 35

Indexed Annuities: Spreads

Answer 35

With an indexed annuity, the insurance company keeps a small cut of the market’s gains first. That cut is called a spread. Example: The index goes up 10% The insurer keeps 2% You get 8% In short: you earn most of the growth, but not all of it.

Question 36

Indexed Annuities: Participation Rates

Answer 36

After the insurance company takes its cut (the spread), it may limit your gain again using a participation rate. Example: Market goes up 10% Minus 2% spread → 8% left Participation rate is 80% You get 6.4% In short: you earn some of the market’s growth, not all—but you’re protected if the market drops.

Question 37

Indexed Annuities: Cap

Answer 37

A cap is a maximum limit on how much interest you can earn on an indexed annuity—no matter how well the market does. Example: Market goes up 12% After the spread and participation rate, your return is 8% But the annuity has a 7% cap ✅ You earn 7%, not more Order to remember: Spread Participation rate Cap In short: a cap limits your upside, but you still get solid growth with no market losses.

Question 38

annual reset

Answer 38

Annuities using the annual reset method evaluate the index yearly and credit interest on the annuity's anniversary date.

Question 39

a point-to-point method

Answer 39

Those using a point-to-point method evaluate the index change from one term to another, potentially spanning multiple years.

Question 40

high watermark method

Answer 40

Annuities with a high watermark method credit interest once every several years but track annual index changes. The largest annual increase among those years determines the interest calculation.

Question 41

Level premiums

Answer 41

maintain the same payment amount each time

Question 42

Flexible premiums

Answer 42

which allow for varying payment amounts each time

Question 43

Immediate annuities

Answer 43

must be purchased with a single premium payment. This makes sense since these annuities begin paying out right away without an accumulation period. In fact, many people refer to immediate annuities as single-premium annuities (SPIAs).

Question 44

Deferred annuities

Answer 44

A one-time lump sum payment Multiple installment payments over time