As we step into June—Annuity Awareness Month—it’s the perfect time to revisit one of the most versatile tools that can be used when planning for retirement: the annuity. By understanding how annuities work and the benefits such as tax-deferred growth and the potential for lifetime income, you can help your clients make informed decisions.
At its core, an annuity is a financial contract between an individual (or entity) and an insurance company. In exchange for premium payments, the insurance company agrees to provide a future income stream—either through withdrawals, annuitization, or as defined by a rider. Because of their long-term nature, annuities are commonly used as part of a retirement strategy.
Key Roles in an Annuity Contract
An annuity contract typically involves three roles:
- Owner: The person or entity (such as a trust, charity, or retirement plan) who funds the annuity and makes decisions about the contract.
- Annuitant: The individual whose life expectancy is used to calculate income payments. The annuitant may be the same as the owner or someone else.
- Beneficiary: The person who receives a death benefit if the annuity has remaining value upon the death of the owner or annuitant.
How can an annuity grow?
There are numerous types of annuities; fixed, variable, and fixed indexed. All of these annuities offer the same contract structure but vary on how the premium can grow. Let’s look at how these three types of annuities have the potential to grow.
Fixed Annuity
A Fixed Annuity credits interest based on a stated interest rate over a pre-defined time period.
Variable Annuity
A Variable Annuity’s account value fluctuates based on the performance of the selected subaccounts and is subject to investment risk, including possible loss of principal.
Fixed Indexed Annuity
A Fixed Indexed Annuity takes the premium payments and credits interest to the account based on the performance of a specified index like the S&P 500, allowing the policy to receive some of the index increase but is not subject to any of the index losses.
Indexed annuities do not directly participate in the market, market indexes, or any stock or equity investments.
For every type of annuity, the account growth is tax-deferred; meaning taxes are not paid until the money is withdrawn from the annuity.
Accessing Your Money
Annuities are designed as long-term financial products. Most come with a surrender period, during which early withdrawals may incur surrender charges and taxes. However, many contracts allow 10% free withdrawals annually without penalty.*
It’s important to note: Early withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59 1/2, may be subject to a 10% IRS penalty, regardless of the insurance company’s terms.
See the resources below for more information on the benefits of annuities.
*Withdrawal charges will be deducted and a Market Value Adjustment (MVA) will apply to withdrawals over the penalty-free withdrawal amount for the first 10 policy years. The MVA may be a positive or negative adjustment.
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