How Annuities Work
While many people buy life insurance to provide financial protection against dying too soon, annuities are a means to protect against living too long. With their many features and various costs, annuities may seem confusing at first. They do, however, have a place in many financial plans and can help individuals provide for their retirement years. So taking a few minutes to understand annuities is time well spent.
Deferred annuities are designed to offer investors tax-deferred growth* and a lifetime stream of income. There are two phases involved in a deferred annuity:
Accumulation period -- when you're making annuity contributions
The main choices you have when purchasing an annuity are fixed, indexed or variable.
Fixed annuities provide a guaranteed return(1) over a specified period of time. Contract owners do not bear any investment risk in a fixed annuity. Some fixed annuities offer interest rate guarantees that may go up and down depending on market performance but will never fall below the rate specified in the annuity contract(1).
An indexed annuity is a type of fixed annuity that offers a fixed account and one or more indexed accounts. The fixed account earns interest at a specified rate of return determined by the insurance company, subject to certain guaranteed minimums. The indexed accounts provide index credits based on various crediting methodologies and can be linked to a number of domestic and international stock and bond indices.
With variable annuities, contract owners allocate their money to separate investment accounts (subaccounts) that suit their investment styles and objectives, with the ability to make tax-free transfers among subaccounts. There is risk involved in a variable annuity since most subaccounts are closely tied to market fluctuations.
Immediate or Deferred
Single Premium or Flexible Premium
Many annuities include a guaranteed minimum death benefit ("GMDB"), pursuant to which beneficiaries receive the full amount of any premiums paid if the annuitant dies. Certain contracts have enhanced GMDBs in exchange for an additional fee.
A guaranteed minimum income benefit (“GMIB”) offers guaranteed minimum annuity payments in the future, regardless of how the contract performs during the accumulation phase of the annuity. This quarantee involves an additional fee.
A guaranteed minimum accumulation benefit ("GMAB") credits an additional amount and guarantees a minimum contract value at some point in the future (for example, the tenth contract anniversary).
Some important annuity benefits are:
Tax-Deferred Accumulation of Earnings(1)
Benefit to Spouses
Various Pay-Out Options Upon Annuitization
Straight life: Guarantees income for life(1). Life with period certain: Guarantees income (for you as the annuitant or your designated beneficiaries, in the event of your death) for a certain period of time, generally from five to 30 years, or your lifetime, whichever is greater. Phoenix offers 10-, 15- or 20-year options(1).
Joint and survivor income: Provides an income payable to you over your lifetime and your joint annuitant's lifetime, whichever is greater.
Joint survivor life with period certain: This option combines some of the provisions listed above. It offers annuity payments for the greater of your lifetime, your joint annuitant's lifetime, or a certain period of time (for example, 10, 15 or 20 years). Phoenix offers joint survivor life with 10 years certain.
Annuity for a specified period of time: Choose to receive payments for a set number of years, from five to 30. Phoenix allows you to change your specified period at your contract anniversary.
Unit refund life annuity: Similar to a straight life annuity payout, this income-for-life option pays your beneficiary a lump sum upon your death.
Lump Sum Payment: Withdrawal of full contract of the annuity. All income taxes will be due on any gains in contract value.
Some annuities allow you to take systematic withdrawals. This distribution option is subject to taxes and penalties* but isn't subject to surrender fees.
Tax Treatment of Annuities
Any growth in your annuity accumulates on a tax-deferred basis. At payout, earnings are treated as ordinary income, not as capital gains.
A qualified annuity is purchased with before-tax dollars; a non-qualified annuity is purchased with after-tax dollars. Exceptions to this include Roth IRAs and non-deductible IRAs. Qualified annuities can be used in IRAs, 403(b) and 401(k) retirement plans, but shouldn't be used solely for the annuities' tax-deferral features but for the other benefits of annuities: lifetime income payments, protection through death benefits and guaranteed fees.
An annuity pays a death benefit to your beneficiaries during the Accumulation period and certain options provide for payment after death during the Annuitization Period. It is subject to income tax for your beneficiary, and may be included in your estate for estate tax purposes.
Once in the payout phase, additional contributions cannot be made into your annuity contract and there is no death benefit per se - payments would then be subject to the provisions of the pay-out option you chose when you began receiving payouts.
Please review this important information regarding variable annuity products:
Charges and expenses: annuities are subject to fees and expenses including surrender charges, mortality and expense risk charges, administrative fees, premium expense charges, rider fees and investment management fees (variable annuities only).
(1) Guaranteed returns are based on the claims-paying rating of your insurer. Fixed annuities are not insured or guaranteed by the FDIC, NCUAA or any other agency that insures deposits.
*Early withdrawals may be subject to surrender charges. Withdrawals of income will be subject to tax, and, if taken prior to age 59-1/2, may also be subject to a 10% IRS penalty except as provided for under IRC Sec. 72. In addition, an interest adjustment, either positive or negative, may be applied to amounts taken as withdrawals or a full surrender prior to the end of an interest rate guarantee period, except if the withdrawal is made within the 30-day window period, is part of the annual 10% free withdrawal, or is for the terminal illness or nursing home waiver.