What annuities are and what annuities are not!  How annuities may fit into your retirement plans.

Annuities are contracts between an insurance company and the owner.  The owner pays a premium to the insurance company in return for some contracted guaranties by the insurance company to the benefit of the owner.  Annuities are guaranteed by the financial strength and reliability of the issuing insurance company.  Traditional fixed annuities were not designed to be an investment to compete with real estate or the stock market, rather they were a safe savings vehicle with interest credited to the benefit of the owner that accumulated value over time.  Annuities are not for everyone.   When considering an annuity, ask 2 basic questions:

What do you want the annuity to do?     
When do you want it done? 

Annuities may not be as liquid as some other savings methods, but may offer a higher yield on your savings.  Annuities can have a contract term as short as 2 years and as long as life.  Annuities are typically divided in two phases.  First, the accumulation phase in which the value of your savings grows,  tax deferred, until withdrawalThe Second, is the payout phase, which can be in a lump sum or equal payments for a specified number of years or for lifetime.

Retirement Financial Planning

The fundamental objective of every retirement financial plan is to ensure sufficient resources are available for a comfortable retirement.  The trick, though, is determining exactly what is “sufficient” and figuring out how to get there.  We don’t all retire at the same age.  We don’t all have the same expenses.  And, of course, we don’t all live to the same age.  As medical treatment and technology have improved and life expectancies have increased, longevity risk – the risk of outliving your retirement savings – has become an increasing concern in retirement planning.

At the same time, private pensions have become exceedingly rare.  Sure, there’s Social Security, but it’s frequently insufficient to meet all regular expenses.  A retirement plan needs to include an additional, reliable income source to make up the difference.

Annuities are a financial product specifically designed to address longevity risk by providing a predictable income stream guaranteed for life.  Although they are not a new concept, modern annuities adapt a proven retirement-planning tool to the modern economy, allowing individual retirees to choose an annuity suited to their individual financial situation, needs, and priorities.

With traditional life annuities, the payments are guaranteed for life, like a private pension you purchase for yourself.

The primary (but by no means only) purpose of annuities in financial planning is to ensure an adequate and  consistent, life-long income stream – thereby insuring against longevity risk.  For this reason, and, because an annuity’s value grows over time, it also acts as a savings or accumulation vehicle.  Annuities are highly customizable and can vary considerably between insurance companies and even between specific annuities.  The secret is to find the specific annuity with features that best fit your specific situation, structured to meet your individual needs.  With new and advanced software to analyze available products, the process is simplified and less time consuming.

An individual annuity is defined according to four chief attributes:

(1) how premiums are paid;

(2) whether payments are immediate or deferred;

(3) the schedule and terms under which payments are made; and

(4) the formula used to measure the annuity’s growth.

Purchasing an Annuity

Annuity premiums can either be due in full at the time of the contract (“single premium”) or paid over time via multiple payments (“flexible premium”).  Flexible premium annuities are generally set up so that the annuitant pays premiums over several years, subject to annual minimum contributions but with the option of making additional payments.  The flexible structure allows you to adjust contributions based on current income and market trends and anticipated future income needs.

Single premium annuities are typically purchased using a lump-sum cash payment, whether from savings or from liquidating other assets.  The premium can also come from the cash value of a life insurance policy through a 1035 Exchange.  Under certain circumstances, IRA or 401k funds can be applied toward a Qualified Longevity Annuity Contract (“QLAC”), sometimes referred to as a “personal pension within IRA.”

Non Qualified vs Qualified

Most annuities are “non-qualified,” which means premiums are paid using already-taxed money.  Payments received from a non-qualified annuity are only taxable to the extent the payment includes growth (i.e., the returned premium is not taxable).

“Qualified” annuities, by contrast, are purchased through a qualified retirement plan or IRA using pre-tax money.  Qualified annuity payments are taxable income except to the extent a portion of premiums was paid using already-taxed money.

With both qualified and non-qualified annuities, growth is tax-deferred, meaning no income tax is owed until payments are actually received from the insurer.

Accumulation Phase

The period during which the annuitant pays premiums to the insurer, and the annuity is growing but not yet paying out, is known as the “accumulation phase.”  The accumulation phase ends when the annuity begins paying out, at which point the “annuitization phase” beings.

Annuity Payments

The term “annuity” is derived from the lifetime payments promised to Roman soldiers upon the conclusion of their service term.

Nowadays, annuities still commonly provide for lifetime payments (“life annuities”), but they are also available with payments guaranteed for a defined period of years, or even as a lump sum.  Annuities can be issued  individually or jointly with a spouse, with payments based on both lifetimes.

Immediate vs Deferred  –  Every annuity is either immediate or deferred.

Immediate annuities begin paying out on the first payment period after the contract is executed.  An immediate annuity purchased in January might make its first payment in February, for instance.  A single premium immediate annuity (“SPIA”) requires one lump-sum premium and then begins making annuitized payments immediately thereafter.  SPIAs are popular with retirees looking to convert a portion of retirement savings into a guaranteed stream of lifetime income.

Deferred annuities do not begin paying out until a future date identified in the annuity contract.  The deferral period is generally somewhere between one and ten years, but longer deferrals are also available, particularly with flexible-premium annuities.

The advantage of a deferred annuity is that the premiums have a longer time to grow prior to annuitization and, therefore, payments are larger than an immediate annuity with a comparable premium.  The combination of premium growth, compounding, and tax-deferred treatment gives deferred annuities a notable advantage over other low-risk savings and investment strategies.  Because no income tax is owed until payments are received, money that might otherwise have gone toward taxes instead continues earning interest.

Payments   Monthly – Quarterly – Yearly

The frequency of payout is determined by the annuitant.  The actual payment amount depends on multiple factors, including the annuitant’s life expectancy, the amount of premium paid, and the growth earned by the annuity.  Payments can be in fixed or variable amounts, depending in part on how growth is measured.

Annuity Growth

There are three basic methods of determining an annuity’s growth:  fixed, variable, and indexed.


Fixed annuities are the original form and the most predictable.  A fixed annuity grows at a pre-set, guaranteed interest rate that serves as a hedge against economic downturns and market volatility.  The rate can be steady for the life of the annuity or periodically adjusted to reflect prevailing rates, with a guaranteed minimum.  The growth potential is not as great as with variable or indexed annuities, but fixed annuities offer failsafe earnings and essentially zero risk of loss.  The stability is reflected in the payments provided by fixed annuities, making them highly useful in budgeting during retirement.


The growth of a variable annuity, and therefore the payment amounts, depends on the performance of investments selected by the annuitant from among multiple options offered by the insurer, normally in mutual funds.  Due to fluctuation over the financial cycle, variable annuities are a riskier investment than fixed annuities  The growth potential may be theoretical higher, but there is also a risk of loss, including loss of principal.  Variable annuities typically have higher fees and sales are regulated by FINRA (securities regulators).

Indexed or Fixed Indexed Annuities

Indexed annuities represent an effort by insurers to find a happy medium between the higher growth potential of variable annuities and the security and stability of fixed annuities.  An indexed annuity’s growth is linked to an equity index, such as the S&P 500, allowing for increased returns during strong markets, but many indexed annuities also come with a guaranteed minimum return, no-loss guaranty, or floor on losses in down markets.  Funds in an indexed annuity are not invested in the market.  The insurance company buys options on an index, and then based on the performance of that index shares the profits, (but not the losses), with the annuitant.

The combination of growth potential and mitigated risk has led to a rapid increase in the popularity of indexed annuities since their introduction.  In exchange for the insurance company’s agreement to absorb some or all losses of the options in down markets, it receives a share of an indexed annuity’s growth when markets are up.  This typically comes in the form of either a growth ceiling (or “cap rate”) above which gains belong to the insurance company – or as a set percentage of earnings paid to the insurer.

For example, if an indexed annuity has an annual cap rate of 6.00%, and the applicable market increases by 8.00%, the annuity’s growth rate would be 6.00%, and the other 2.00% would go to the insurance company.  Indexed annuities usually allow for significant flexibility in choices of indexes to follow

In general, an indexed annuity with greater growth potential in the form of a higher cap rate would also have lower guaranteed returns.  Conversely, a higher guaranteed rate of growth typically translates to a lower cap rate.

Annuity Withdrawals

A withdrawal occurs when the annuitant taps the value of the annuity ahead of schedule and is therefore distinct from regularly scheduled payments.  Withdrawal options vary from company to company and product to product and often come with a fee.  Even so, an annuitant might want to make a withdrawal in response to a large unexpected expense or emergency or for a one-time purchase.  Many annuities have free annual withdrawals, typically 5% to 10% of the initial premium or current value.


A “surrender” is when an annuitant cashes out the annuity for a single, lump-sum payment.  Surrendering an annuity terminates the contract along with the right to receive any future payments.  Annuities usually have a surrender fee, typically measured as a percentage of the annuity’s value.  However, most annuity contracts gradually decrease and phase out the surrender fee after the contract has been in place long enough.

Some annuities waive surrender fees altogether upon the occurrence of a specified event, such as a serious medical illness or injury or the annuitant’s permanent need for long-term healthcare.

Partial Withdrawal

A “partial withdrawal” is when the annuitant accesses some of the annuity’s value but allows the contract to otherwise remain in place.  Partial withdrawals may come with a fee until the annuity has been in place long enough, but many permit early withdrawals of a specified percentage of the annuity’s value without penalty.

Importantly, partial withdrawals result in a decrease in the amount of future payments, and the amount of any withdrawal which constitutes growth will be taxable income.  Additionally, premature withdrawals from a qualified annuity result in an IRS penalty.

Annuity Survivor Benefits

Annuities may be structured with a single or joint annuitant (usually for spouses).  The payout amount may be less for joint annuitants and is typically based on the gender and life expectancy of the younger spouse

Initially traditional annuities did not offer any survivor benefits.  When the annuitant died, the right to payments ceased.  This arrangement created the risk of dying early and not receiving back even the premium used to purchase the annuity.  Due to this concern, most modern annuities include some form of survivor benefits allowing for payment to a designated beneficiary upon the annuitant’s death if the annuity has not yet paid out a threshold amount.

Survivor benefits are usually based on the premium paid compared to the total amount paid out.  A popular provision gives a surviving beneficiary the right to receive a refund of any premium left over after subtracting the total payments received by the annuitant.  Alternatively, a life annuity might provide payments to a survivor if the annuitant does not live to a specified age.

Nearly all deferred annuities will pay the entire annuity value to a named beneficiary if the annuitant dies before payments commence.  In most cases, a surviving beneficiary can choose between accepting the annuity’s value as a lump sum or through multiple payments over an extended period.  If the beneficiary is a surviving spouse, he or she usually also has the option of allowing the annuity to remain in place under the same terms.

IRS rules relating to a beneficiary’s receipt of annuity payments are complex, and a lot can depend on the precise language of the specific annuity contract.  It is a good idea for anyone inheriting rights to an annuity to consult with an accountant or tax attorney before making any decisions about how to accept payment.

Popular Types of Annuities

Different types of annuities vary as to key features like how long payments continue, whether survivors have any right to payments following the annuitant’s death, and how the annuity is funded.  Importantly, an individual annuity can have features of more than one type of annuity (e.g., a SPIA can also be a life annuity).  Though the precise terminology may vary between insurance companies, these are some popular forms of annuities:

Single Premium Immediate Annuity (SPIA): 

SPIA is an annuity funded with a single, lump-sum premium payment that begins paying out immediately.  SPIAs are useful in converting substantial current liquidity, such as from accumulated retirement savings or proceeds of a legal-settlement, into a long-term income stream.  Purchasing a SPIA with periodic payments roughly equal to fixed expenses (e.g., health insurance, real estate taxes) is a popular strategy in retirement planning.

Life Annuity:

Also referred to as a “life income annuity,” a life annuity provides guaranteed income for the life of the annuitant(s).  Upon the annuitant’s death, payments cease, and there are no payment rights vested in survivors.  Life annuities are a time-tested means of insuring against longevity risk.  Life annuities are not popular, except for persons who have no dependents or beneficiaries.

Life with Premium Refund:

This type of annuity works like a life annuity except that if, upon the annuitant’s death, the annuity has not yet made payments totaling at least the amount of premium paid, the remainder is refunded to a designated beneficiary or to the decedent annuitant’s estate.

Life with Period Certain:

The annuity pays out for the longer of the life of the annuitant or a defined number of years.  If the annuitant dies before the defined period expires, remaining payments are paid out to a designated beneficiary or to the estate.

Joint and Survivor Income Annuity:

The annuity is guaranteed to pay out for the lives of two annuitants (usually spouses).  Depending on the contract language, the payment amount will either stay the same or will be reduced upon the death of the first annuitant.  These annuities can also be set up so that if a primary annuitant dies first, payments are reduced, but if the secondary annuitant dies first, payments stay at the same amount.

Period Certain Annuity:

An annuity that pays for a “period certain” pays out for a defined number of years regardless of the annuitant’s lifespan.  If the annuitant is still living at the end of the period, payments cease.  If the annuitant dies during the period, payments are made to the annuitant’s estate or to a named beneficiary for the rest of the period.

Multi-Year Guaranteed Annuity (“MYGA”):

A MYGA is a specialized deferred annuity under which the annuitant makes a lump-sum premium payment to the insurer, and the insurer retains the premium for a defined period (usually three to ten years) during which it earns interest at a fixed rate. (similar to a “CD” issued by a bank,  but MYGA’s are issued by an Insurance Company and not insured by the FDIC.  At the end of the period, the annuitant can accept a lump-sum payment, roll over the funds into another MYGA, or receive annuitized payments over an extended period. A MYGA allows the annuitant to take advantage of tax-deferred growth with minimal risk in advance of retirement.

Structured Settlement Annuity:

Legal settlements that are “structured” involve multiple payments over time – generally to reduce tax liability, preserve Medicaid eligibility, and/or to ensure a long-term income stream to the injured party. To facilitate the structured settlement, the defendant’s insurance company can purchase an annuity for the benefit of the plaintiff.  Structured settlement annuities are usually, but not always, paid for a period certain.

Charitable Gift Annuity (“CGA”):

A CGA is a contract between a donor and a large charity or non-profit organization like a university.  The donor agrees to make a large contribution to the non-profit and, in exchange, the non-profit invests the money and makes annuity payments to the donor for the rest of his or her life.  The donor receives a partial current-year tax deduction, and the non-profit keeps the funds left over after the donor’s death.

1035 Exchange:

A 1035 Exchange is not a specific type of annuity but, instead, a means of converting an existing cash-value life insurance policy into an annuity without incurring any immediate tax consequences.  In a typical scenario, someone who has a whole-life policy with substantial cash value reaches retirement age and has less of a need for life insurance.  Through a 1035 Exchange, he or she converts the policy’s cash value into an annuity to help fund retirement.  The 1035 exchange avoids the big tax bill that might otherwise be due for the policy’s growth had the insured simply surrendered the policy for cash.  The new annuity inherits the tax basis of the prior whole life policy.


An annuity rider is a provision you can add to your annuity contract to customize the benefits to ensure it meets your specific financial needs. The main categories of annuity income riders are guaranteed minimum living benefits and guaranteed minimum death benefits.  Additionally, riders can cover accelerated benefits for long term care, in home or in an assisted living facility. The more riders you add to your contract, the more expensive your annuity will be.  Fees vary from company to company and by the product selected.

Beware!  Discussion of the “gotchas” in annuity marketing.

“Bonuses”, “back tested results”, “hypothetical earnings”, “hypothetical performance results” are all marketing ploys to get your attention.  Don’t buy any annuity based on anything other than the contractual guarantees within the contract that meet your needs.  Know the specific details of the contract before making a purchase.  If an annuity’s performance exceeds the contractual guaranties, then consider that as gravy, but not the primary basis for making a purchase.


There are a lot of nuances when it comes to annuities and knowing which companies offer the best annuities for your specific situation, therefore, it is important to make sure you get the best annuity for you, based on your specific needs, goals and objectives.

If you are in the market for an annuity or have any questions, please give us a call today for a complimentary strategy session with a seasoned professional, supported by an unparalleled research department.

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