Intermediate Guide to Annuities

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1. What happens if I die before I start taking income?

If you die, your full contract value will pass along your beneficiary, according to your contract. The contract value will be the initial premium plus any bonus, interest earned less any withdrawals. The beneficiary you nominated in the contract will receive the death benefit. You can have more than one beneficiary.

2. What if I bought an annuity I no longer want or need the funds for an emergency?

You can always surrender your annuity contract. You will have to pay a surrender charge for this procedure, according to the surrender charge schedule in your contract. Just keep in mind that if you do this before the age of 59 ½, you will also be penalized with a 10% excise tax on your early withdrawal.

Also, you can transfer the money to another annuity plan by using a 1035 exchange. You will still have to pay the surrender charge, but you won’t get penalized with the 10% IRS penalty if you are under 59½. However, you may have to start a brand new surrender charge schedule.

3. What are the main features of fixed index annuity contracts?

There are two main features about fixed index annuity plans that you must understand before buying this type of annuity. They have the greatest effect on the amount of additional interest that may be credited to your annuity. These are the indexing method and the participation rate. There are also other features you must know, so let’s take a look at all of them:

The indexing method

This feature refers to the approach used to measure the amount of fluctuation or change, if any, in the index. There are several indexing methods; some of the most common ones are explained later on, including high-water mark, point-to-point and annual reset (also known as ratcheting).

The participation rate

The participation is a factor which determines how much of the index increase will be linked to the index interest. Essentially, it is used to calculate your index-linked interest. For instance, if the index change is 10% and your participation rate is 60%, the index-linked interest is 6% (10% x 60% = 6%). Most insurance companies guarantee a participation rate for at least a year (or for the entire term). After this period has elapsed, the company may reevaluate the participation rate. Some annuity contracts specify and guarantee that your participation rate will never go lower than a set minimum amount, or higher than a set maximum amount.

The term

The index term is simply the period during which the index interest is calculated. The interest is added and credited to your annuity at the end of each term. Usually, terms can vary between one to ten years, but six or seven years are the most common periods. While some annuities offer single terms, others offer multiple, consecutive terms. These multiple-terms annuities have 30-days window between each separate term, during which you can withdraw your money without additional penalty. In case you have installment premium annuities, whenever you pay a premium, a new term begins for that particular premium.

Cap rate or Cap

Some insurance companies put caps or upper limits on the index-linked interest rates of their annuities. This maximum rate of interest is the maximum you will actually earn. The example above has an index-linked interest rate of 6%; if a cap of 5% is enforced, your actual index-linked interest rate becomes fixed at a maximum of 5%, not 6%. Keep in mind that not all annuities have a cap rate.

Floor or Fixed Index-linked interest

The floor is the minimum interest you will earn on your annuity. The most common floor is 0%, and it assures that even if the index goes below this point, your earnings will be zero, and not negative. Similar to caps, not all annuities have a specific floor on index-linked interest rates. In all cases, your annuity will have a minimum guaranteed value.


Certain annuities use an average of the index’s value instead of the actual value of the index on a specific day. This averaging occurs either at the beginning or at the end of the term of the annuity. In some cases, the averaging can be done throughout the entire term.

Interest compounding

Some annuities will pay a simple interest during an index term. This means that the index-linked interest is added to the original premium. However, it will not compound during the term. Other annuity contracts will pay compounding interest during a term. This means that the index-linked interest which has been credited also earns an interest in the future. In both cases, the interest earned during one term is compounded in the next.

Margin, spread or administrative fee

A margin, spread or administrative fee is a percentage that is used instead of, or in addition to, a participation rate. This percentage represents a calculated change in the index. The percentage is then subtracted from your index-linked interest. Some annuities use this type of index-linked interest rates – where the margin, spread or administrative fee is subtracted from the initial interest rate.

For instance, if the calculated change in the index is 10%, your annuity might specify a margin of 2.45%. This percentage will be subtracted from the original interest rate, resulting in an interest of 7.55%. The subtraction only occurs if the resulting interest rate is not negative (the interest must be 0% or above).


This is usually in relation to any additional Premium Bonus that is added to the contract. The Premium Bonus earns interest but vests over the life of the contract. If you surrender your contract before the end of the term, then the you will lose the unvested amount of the Premium Bonus.. The vested (or credited) percentage generally increases as the term comes to its end. The percentage is always 100% at the end of the term.

4. What are the different methods of crediting index-linked interest?

Annual Reset

This method takes into consideration the index value at the end of the contract year compared to the index value at the start of the contract year. The index-linked interest is then calculated and added to your annuity each year, on your contract anniversary date. The new starting index value for the new contract year is “reset” to the same value as the ending value of the index.

High-water Mark

In this case, the index-linked interest, if it exists, is calculated by looking at the index values at various moments during the term. The interest is based on the highest level attained by the index over the given term. Then, the interest is added to your annuity at the end of each term.


In this method, the index-linked interest, if any, is based on the difference between the index value at the start of the term and the index value at the end of the term. Then, the interest is added to your annuity at the end of each term.

The point-to- point method can either be an annual calculation or a monthly point-to-point calculation.

5. What are the different features pertaining to the different indexing methods?

Annual Reset Feature:

Because the interest you earn is “locked in” every year and your index value is reset at the end of every year, any future decreases of the index will not affect the interest rate you already earned. This means that your annuity which uses the annual reset method may be more profitable than annuities using other indexing methods. Annual reset works as a one-way ratchet. While the index can fluctuate up or down during a term, you will earn interest in years that the index has positive growth.

Annual Reset Trade Off:

Annuities using annual reset typically use an averaging limit or a cap, in order to limit your total interest that you can earn each year.

High Water Mark Feature:

In this scenario, the interest is calculated using the highest possible value of the index in the contract anniversary during the term. This method ensures that your profits will be higher than in other methods, particularly if the index reaches a high point early or in the middle of the term, followed by a drop off near the end of the term.

High Water Mark Trade Off:

In these types of annuities, the interest is credited only at the end of the term. In some annuities which use this method, if you choose to surrender your annuity before the end date of the term, you may lose the index-linked interest for the whole term. On the other hand, in other annuities, you may receive the index-linked interest according to the highest anniversary value to date or according to the annuity’s vesting schedule. Similarly, annuity contracts that use this method may employ a lower participation rate than other annuities using different methods. Also, they may use a cap to limit the total interest you might earn over a certain term.

Point-to-Point Feature:

In this case, the interest cannot be calculated before the end of the term. The use of this method may allow a higher participation rate than the annuities which use other methods.

Point-to-Point Trade Off:

Interest is not credited until the end of the term. Some annuities have long terms of up to 7 years. In this scenario, you will not be able to get the index-linked interest gains until the end of the term, and may lose interest if you take out withdrawals prior to the end of the term.

6. What is annuitization?

We do not recommend annuitization because you lose control and access to your principal. 

The annuitization refers to the period that comes after the accumulation phase, where you start receiving payouts. When you start receiving these payments, your annuity is annuitized, and the process is called annuitization. Always pay particular attention to the annuitization moment: once an annuity is annuitized, the process cannot be reversed. Similarly, after the annuitization procedure, you cannot withdraw funds from your principal in any circumstance. The annuitization process essentially changes your lump sum of cash in a regular income – this process is irreversible and inflexible.

7. What’s the difference between the guaranteed rate and the current rate on an annuity?

Simply put, the guaranteed rate is the rate stated in your annuity contract and is a State requirement. This is usually the minimum rate that the annuity will pay you, no matter what. On the other hand, the current rate is the rate your insurance company displays and uses to pay the interest at the current time. This rate is usually higher than the guaranteed rate. The current rate is not contractual and may vary over the life of the contract.

8. What is the floor of a fixed annuity?

The floor is the minimum guaranteed amount of money credited to your account.

9. What factors influence the annuity income?

There are several factors that can influence your annuity’s performance and income. The income you receive depends on the interest rate, the principal and many other factors. Here are some of them:

  • gender – when all things are equal, males usually receive larger payments, because of their lower life expectancy when compared to females
  •  age – the income is lower if you are younger; this is because your life expectancy is longer and the income has to be paid over more years;
  • features – the income is lower if you choose more guarantees; similarly, the income is higher for higher risk annuities; for instance, an annuity which guarantees payments for a set period of time (period certain) has lower payments than an annuity which stops after you die;
  • interest rates – payments are higher if your annuity was purchased when the interest rates where high; similarly, if the interest rates were lower, your income will be lower. To mitigate these risks, you should consider buying multiple income annuities over a period of years, at different interest rates;

10. Are income riders offered through insurance carriers identical?

Absolutely not. Income riders vary enormously between carriers and also within a carrier’s own product range.

Riders are unique to each insurance carrier, and sometimes they are unique to every specific annuity offered. An insurance company may offer completely different income riders, when compared to other insurance companies, even if the products are similar.

You should always make sure to understand the specifics of your contract, the guarantees and the particularly the fees involved. Also, look at multiple carriers – this will help you choose the best one for you. For example, an income rider or a death benefit rider growth could be based on either simple interest or  compound interest. In this scenario, this small detail can make a huge difference in the future.

11. What are the specific costs of an annuity rider?

Almost all riders come with a fee. Usually, they are applicable for the life of the policy, however some carriers allow you to cancel the rider and the fee will no longer apply. The rider’s cost is typically deducted from the accumulation value stated on the contract, and due on the anniversary date. This fee will not come out of the rider value –  one of the main advantages of the rider strategy.

12. How do I report my profits for taxes?

The money credited to your annuity during the accumulation phase is not reported or taxed. You are only taxed on your money after the annuitization, once you start receiving payments. Then, you use the IRS Form 1099 for tax reporting purposes.

13. Should a retiree purchase an immediate annuity?

When you look at it, an immediate annuity seems a great way to ensure an additional income for your retirement. After all, if you have a lump sum of money available, you can use it to buy an immediate annuity and receive regular payments for the rest of your life. These guaranteed payments  should be a great way to supplement your income. Also, you get a tax incentive: the part of the payout that is a return of the principal is excluded from your taxable income.

However, there are some risks. You have to know the risks before buying an immediate annuity. For instance, a lifetime of periodic, steady and guaranteed payments look good, but you are not protected against inflation. Also, you are literally gambling on whether you live long enough to get all your money back. Let’s say you buy an immediate annuity for $100,000 when you are 65 years old. If you die after collecting only $50,000 and don’t have a beneficiary, your insurance company gets the rest of your money.

You can protect yourself and your heirs in the event you die too soon by opting for a “certain period” type of payout. In this case when you die, your beneficiaries will still receive payments until the end of the period. You could also opt for a “joint-and-survivor” type of annuity, whereby your surviving spouse gets the payments. There is also a “cash refund” option whereby the remaining principal of your initial investment is given to your heirs or beneficiaries.

To counter the effects of inflation, some annuities have quasi-inflation adjusted payments. For instance, some companies offer a guaranteed increase in payments of 10 percent at set intervals (usually every three years) for the first 10, 15 or 20 years. The payments are then adjusted to the cost of living, but only with a 3 percent maximum increase every year. These features obviously come with a cost: if you choose these protection features, your payments will start out lower than the normal payouts.

On the other hand, some insurance companies sell immediate annuities which offer potentially higher returns, but they are riskier. These so-called immediate variable annuities do offer better payments, but they are closely linked to the performance of a basket of mutual funds, which are intrinsically risky.

Keep in mind that, if you want a reliable, predictable retirement income, you should go for a balanced portfolio of mutual funds, annuities and savings. If you want additional guarantees to ensure you won’t outlive your savings, you should plan out your withdrawals over a longer time span or allocate more assets to annuities.

14. I am approaching 80. What should I know about purchasing annuity?

You should take into consideration your age, health and life expectancy, particularly look at your family history when you want to buy a Retirement Income Annuity. People are living much longer now and insurance companies offer annuities up to age 90. Another important consideration is your risk tolerance. Many retirees want safety from market risk and choose either fixed or fixed indexed annuities as vehicle for their savings.

As opposed to life insurance policies, annuities do not require any underwriting regarding your health. However you will not be able to get an annuity if you already reside in a nursing home or care facility.

15. Considerations and questions

Consider the following before buying any type of annuity:

The money you put in the principal, for a non-qualified annuity, may be post-tax money. If you want to put after-tax money into your annuity, you can put as much money as you want, without any issues. Of course, before putting this money into an annuity, you should consider putting the maximum pre-tax money into a qualified retirement plan, such as an IRA, 401(k), 403(b) or SEP. Keep in mind that your annuity can fund these qualified retirement plans, as long as they are in the accumulation phase. If you want to do this, there are several contribution limits that will apply. Also, federal tax codes require that you take minimum distributions after April 1st of the calendar year after you reach the age of 70 ½. If you fail to do this, you will be penalized with 50 percent of the shortfall amount. Keep in mind that, once you have funds in your 401(k) or 403(b), you cannot withdraw any money before you reach the age of 59 ½, except for certain special cases, such as disability, severance from employment or death. If you do take withdrawals based on these exceptions, you may be subject to the 10 percent federal tax penalty for pre-59 ½ withdrawals.

The annuity’s expenses can vary a lot. Pay attention to the fees, charges and other costs that your annuity may incur. Make sure you find the best offer on the market, before buying your annuity. There are several independent rating services, like Lipper Analytical Services or Morningstar, which publish full reports on Variable annuities available on the market. Don’t necessarily go for the cheaper annuity; similarly, don’t go for the most expensive, as higher fees and expenses can offset your gains.

Pay attention to your tax situation as it pertains to all of your investment income. Annuity income is subject to normal income tax. For instance, if your ordinary income tax during retirement is higher than the long-term capital gains tax rate, you will essentially pay higher taxes overall. Obviously, you still get the tax deferral on your annuity earnings during the accumulation phase. Other investments are not tax deferred and you will pay taxes each year albeit at a lower tax rate. Your tax advisor will help you with your tax planning.

If you are determined to buy an annuity, here are some questions you should ask yourself before signing the contract:

  1. Have you done your market research? Have you checked the options?

Annuities are long-term investment products, so you’ll have to make sure you choose the best provider. Pick a company that has experience in the industry a good track record and will be in business for your lifetime. A good insurance company can offer multiple features, a wide range of choices, prices and flexibility.

  1. Is the rate on the fixed annuity too good to be true?

Obviously, clients prefer the best, most competitive interest rates that they can find. However, some interest rates simply look too good to be true. What’s more, if the company offers bonus rates, special offers and other high interest products, make sure you check the underlying interest rate, additional fees or charges. Also, pay attention to the surrender charges. Keep in mind that bonus interest rates or special offers are only guaranteed for a limited amount of time – you have no guarantee that the normal rates will still be competitive.

  1. What are the annuity’s surrender fees? How long are they in place?

Always check out the annuity’s surrender fees and the surrender charge schedule. Typically, they hover around 10 percent and decline after several years, reaching 0 after by the end of the contract period. If the surrender fees are high, and they don’t decrease over time, you may find yourself locked in a contract that you have no way of exiting without a high surrender fee.

  1. What is the track record of the funding options offered in a variable annuity?

Make sure to check the track record for the funding options, but don’t fall for the last month’s top performer. Look for good returns over a longer period, typically 3 to 5 years. There are several newspapers who publish these charts, such as Wall Street Journal or Barron’s. Also, you can check the history of various funding options in Lipper Analytical Services publications and in the Morningstar. Keep in mind that past success is not always an indication or guarantee of future performance.

  1. Does a variable annuity offer multiple fund options? What happens if you change your investment strategy?

In this case you should constantly be on the look-out for new funds to invest in. You should always try to diversify your retirement savings, particularly as your needs change.

  1. Will your ordinary income tax be larger than the applicable capital gains rate when you begin to take distributions?

In case this happens, you will pay more in taxes if you choose annuities over different investment options that are taxed at the capital gains rate. However, your money accumulates in the annuity without having to pay taxes. If you choose an annuity, you can still enjoy the tax-deferred aspect, while your money grows.

  1. What is your insurance company’s rating?

Whenever you find an insurance company that sells annuities, make sure to check its ratings. Of course, annuities can be sold by agents, brokers or banks, but the annuity is always issued by an insurance company. Always check the ratings of the insurance company. Is it financially strong? Does it have good practices? What are their clients saying about it? All these questions are important before signing any type of annuity. You can check up on your insurance company on the internet, as well as at your state’s Department of Insurance.

  1. How secure do you want the annuity to be?

If you want a guaranteed, predetermined income at a fixed interest rate, then a fixed annuity is your best bet. On the other hand, if you want a higher return for a higher risk, then a variable annuity is best for you. Increasingly popular are fixed indexed annuities that offer a potential higher return from the growth of a stock market index but with no risk to the principal. Income riders can be added to either type of annuity.

  1. How do you want to pay for your annuity?

There are several ways you can pay for your annuity. You can either pay a lump sum for your annuity, in which case a single premium annuity is better suited. On the other hand, if you want to make regular payments, then a flexible annuity is your ideal choice.

  1. When do you want to receive payments from your annuity?

An immediate annuity plan is your best bet if you want to receive payments right away. If you want to receive payments at a later date, similar to a retirement plan, you should buy a deferred annuity.

  1. How do you want your paychecks to be paid out?

If you want the highest payments for the rest of your life, and have no beneficiaries you should go for a straight life only option. If you have beneficiaries you should add a period certain to the life option.

If you want payments for you and, after you die, for your spouse, then you should choose a joint-and-survivor option.

If you want steady payments for the rest of your life, but in case you die, you want the remaining lump sum to go to your beneficiaries or heirs, you should choose a life annuity with a refund feature option.

16. What questions should I ask the advisor who sells the annuity?

Here are some questions that might help you, before buying the annuity:

– Is this a fixed, variable or fixed index annuity?

– Is this a multiple premium or a single premium contract?

– What is the initial interest rate? How long is it guaranteed?

– Is there a bonus interest rate? Is there a vesting schedule?

– What is the minimum interest rate? Is it guaranteed?

– What is the renewal rate for crediting annuity contracts that were issued last year?

– Are there any surrender charges? How much are they? How can I end my contract early and what fees are involved?

– Can I withdraw my money without paying the surrender charge? Will I lose the interest?

– Can I choose an income rider or death benefit rider? What are the fees? How much income will I get? Is it guaranteed?

– Does this annuity waive withdrawal charges in case of terminal illness, death, disability or confinement?

– Is there any MVA (market value adjustment) feature in my annuity?

– Are there any charges or fees that can be deducted from my contract or premium value?

– I want to pick a longer or shorter payout period for my annuity. Is my accumulated value or interest rate changing?

– Is there a death benefit included? What are the details?

– How can I pay for my annuity? Can I change the payment option?

17. Want to learn more?

Our company has access to qualified and trained advisors across the United States who can help you differentiate the various types of annuity products and services. This can help you decide on the best product for your retirement and income needs.

To get more information and discuss the specifics, please fill out the form to speak to one of our annuity specialists.

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