What an annuity is
An annuity is a contract with an insurance company. You pay a lump sum or a series of payments, and the insurer promises either growth on a tax-deferred basis, a stream of income, or both. Annuities are used mainly for retirement: to turn savings into income you cannot outlive, to add guaranteed income on top of Social Security and pensions, or to defer taxes on savings beyond retirement plan limits.
Main types of annuities
- Immediate annuities start paying income within about a year of purchase, for life or a set period.
- Deferred annuities accumulate value first and pay out later, through withdrawals or annuitization.
- Fixed annuities credit a guaranteed interest rate for a set period.
- Fixed indexed annuities credit interest based partly on a market index, subject to caps or participation rates, with protection against index losses.
- Variable annuities invest in subaccounts similar to mutual funds, so values rise and fall with markets. They are securities registered with the SEC and sold under FINRA rules.
Fixed and fixed indexed annuities are regulated by state insurance departments. Optional riders, such as guaranteed lifetime withdrawal benefits or enhanced death benefits, add guarantees for an extra annual charge.
Fees and surrender charges
Annuity costs can be significant. Variable annuities often carry mortality and expense charges, administrative fees, fund expenses and rider fees. Most deferred annuities impose surrender charges if you withdraw more than a free amount during the first years. The SEC's investor guidance gives an example of a 7 percent charge in the first year that declines each year until the surrender period ends. Many contracts let you withdraw a portion each year without a charge.
Taxes
Earnings inside a nonqualified annuity grow tax-deferred and are taxed as ordinary income when withdrawn. According to IRS Publication 575, the taxable part of most distributions taken before age 59 and a half is subject to an additional 10 percent tax, with exceptions such as death, disability and certain series of substantially equal payments. Holding an annuity inside an IRA or 401(k) adds no extra tax deferral. A Section 1035 exchange allows moving from one annuity to another without current tax, though a new surrender period may start.
Consumer protections
Most states have adopted the NAIC's 2020 revisions to its Suitability in Annuity Transactions Model Regulation, which require producers to act in the consumer's best interest and document the basis for a recommendation. Annuity contracts include a free look period, ten days or more depending on the state and product, to cancel. If an insurer fails, state life and health guaranty associations protect annuity values up to limits set by state law, commonly $250,000 in present value per owner per insurer.
How to choose an annuity
Start with the job you want it to do: lifetime income, principal protection or tax-deferred growth. Compare guaranteed rates, caps and participation rates, total annual costs, the surrender schedule and the insurer's financial strength rating. Avoid putting money you may need soon into a contract with a long surrender period, and be cautious about replacing an existing annuity if it restarts surrender charges. Ask for every fee in writing and compare several offers.
How payouts and claims work
You can take money through partial withdrawals, systematic withdrawals, a guaranteed withdrawal rider or by annuitizing, which converts the value into scheduled payments. When the owner dies, beneficiaries file a claim with a death certificate and choose a payout option, each with different tax results. Keep beneficiary designations current. Polis Re does not offer an annuity calculator, but you can request quotes to compare annuity offers from several insurers. Contracts are issued by licensed insurers and placed through licensed producers in your state.
