Annuities – Frequently Asked Questions

An annuity may contain some of the provisions typically found in a life insurance policy, such as an incontestability clause. However, because an annuity is an investment vehicle, the most important provisions are those relating to payment and penalties:

Payment provisions: Annuities set forth how the investment will operate and when the periodic payments will be made. The two most common type of payment plans are deferred annuities and immediate annuities. Immediate annuities are generally used to convert a lump sum such as an inheritance into a lifelong income stream by providing the annuitant with monthly payments as soon as the account is set up. A deferred annuity accumulates capital over the annuitant’s working life to build a sizable income stream for retirement. The regular contributions the annuitant makes to the deferred annuity account are tax sheltered until they are withdrawn as regular payments at a later date. This period of regular contributions and tax-sheltered growth is called the accumulation phase.

Tax Status Provision: This provision sets forth whether there are IRS tax benefits beyond the tax-deferred growth in the annuity, and will be characterized as either Qualified or Non-Qualified. Qualified tax status often comes from employment-sponsored savings plans.

Surrender penalty provisions: Annuities typically contain surrender penalties that apply when money is withdrawn before a designated date. Surrender penalties are imposed to offset acquisition costs, principally the commissions paid to selling agents. Surrender penalties are what causes an annuity to potentially be a bad investment, as surrender penalties are often a considerable percentage of the total value of the annuity. At the same time, investors have to be wary of the additional tax penalty should an annuity be cashed out prior to 59.5 years of age. It is important to remember that these provisions must be clear, because the penalties are in a form contract drafted by an insurer, and therefore they must be stated in plain, clear and conspicuous manner.

Crisis Waiver provisions: Many annuity contracts contain a provision that waives surrender charges if certain conditions are met. These provisions allow for withdrawal of some or all of the annuity’s accumulated value if a specific crisis condition exists such as nursing home admission, suffering a terminal illness, unemployment and disability. However, crisis provisions vary from contract to contract, and may require the contract be in force for a minimum numbers of years or for the owner to have reached a specified age. Also, crisis waivers may require an additional premium.

Death Benefits provisions: Death benefits in an annuity contract usually depend on whether the contract owner/annuitant dies before or after the annuity starting date. Typically, the death benefits are payable if a death occurs before the annuity starting date.

Yes. The potential adverse effects of an annuity provision by seniors led to California legislation in 2011 to provide for additional protection for seniors. The law requires that an insurance agent now complete California approved-training to sell annuities, and prohibits an agent from advocating the purchase, exchange or replacement of an annuity unless the agent can show reasonable grounds for believing that the annuity is suitable for the consumer. California Insurance Code section 10509.914(i) provides suitability factors that include age, income, and financial objectives.

Seniors are also afforded additional protection under California law to help ensure that they properly review the annuity contracts being sold by insurers. When selling to a person over 60 years old, insurers are required to list the surrender penalties in bold print on the cover of the annuity contract or the location of the surrender information or the location of the surrender information within the contract. Insurers are also required to post a notice on the front page informing a person 60 years of age or older that they have a 30-day free-look period. The free-look period provides that the senior has 30 days after purchasing the annuity/policy to cancel the annuity/policy free of any cancellation or surrender charges. If the annuity/policy is canceled, all premiums and fees will be refunded.

It is always good practice for seniors to follow these tips when purchasing or replacing an annuity policy:

• Obtain all proposals in writing;
• Do not be pressured into buying any insurance product and take enough time to review the information before making any decisions;
• Do not sign anything you do not understand;
• Consider having a trusted family member, friend or advisor participate in discussions concerning the purchase of any insurance product;
• Make sure the agent, broker and insurance company are properly licensed to sell the product you are considering purchasing;
• Make sure you receive full disclosure of all information relating to the benefits and possible negative consequences regarding the replacement of an existing annuity; and
• Obtain a full disclosure of all surrender charges and related time frames in connection with an annuity prior to purchase.

Time of Payment- Annuities vary as to whether payouts are immediate or deferred.

Immediate Annuities: As its name suggests, investors receive payments from immediate annuities immediately upon investing. Immediate annuities provide the annuitant with monthly payments as soon as the account is set up. Annuitants may choose between payments for a set period (e.g., 20 years), for the rest of their life or even for a combination of the two.

Deferred Annuities: Payments to annuitants under deferred annuities do not begin until some future date. Generally, payment begins in deferred annuities after retirement. Deferred annuities allow you to either make a lump sum investment or allow annuitants to make regular contributions over the course of their working life during what is called the accumulation phase. An advantage of deferred annuities is that during the accumulation phase taxes are deferred until the annuitant begins receiving payments.

Investment type: Annuities also vary in terms of whether they provide a fixed or variable rate of return.

Fixed Annuities: Fixed annuities offer a guaranteed rate of return over a certain period of time. There are two major types of fixed annuities. The first type is Guaranteed Return Annuities. These annuities offer a guarantee that annuitants will receive at least 100% of their investment such that nothing can impact the annuitant’s principal. The second type is Market Value Adjustment annuities which do not guarantee an annuitant’s principal and work much like bond. These types of fixed annuities generally pay more than Guaranteed Return Annuities.

Variable Annuities: In variable annuities, the annuitant pays the issuer principal, either lump sum or periodic payments, and the issuer guarantees the annuitant variable payments overtime. There are a broad range of options available for those looking to purchase variable annuities. Variable annuities enable annuitants to select different portfolios called sub-accounts which are tied to market performance which can vary between law risk and high risk investments. Some variable annuities also offer death benefits under which, upon the death of the annuitant, benefits are paid out to the annuitant’s beneficiaries.

Liquidity Options: Annuities also vary in terms of the level of liquidity they offer.

With Withdrawal/Surrender Penalties: These types of annuities, often called “no-surrender annuities,” allow a person to withdraw up to a certain amount of money from his or her annuity in any given year. Beyond this set amount however, a surrender charge comes into play which sets a penalty for making early withdrawals beyond the penalty free withdrawals. Even more problematic for annuitants, any withdrawal, whether or not it is over or under the free withdrawal amount, may be subject to taxes if an annuity is cashed out prior to 59.5 years of age. These provisions may cause significant problems for annuitants who need an immediate withdrawal from their annuities.

Without Withdrawal/Surrender Penalties: These annuities do not contain surrender charges, allowing for increased liquidity. However, even non-surrender annuities may be subject to tax penalties if money is withdrawn when the owner is under the age of 59.5.