Annuities are the mirror image of life insurance: life insurance protects against dying too soon, an annuity against outliving your money. Exam questions on them come down to a few ideas.
Two phases
Every annuity has an accumulation phase, when money goes in and grows, and a payout phase, when it comes back out as income. The annuitant is the person whose life the payments depend on.
Immediate or deferred
An immediate annuity is bought with a single premium and starts paying income within 12 months of purchase. A deferred annuity builds value first and pays later; tax on the credited interest is deferred until money is taken out.
Fixed, variable and indexed
- Fixed: the insurer credits interest with a guaranteed minimum rate.
- Variable: the owner picks investment accounts, and the value rises and falls with them. Fees are charged as a percentage of the account: a 0.15% yearly administration fee on an average account value of $100,000 costs $150 for the year.
- Indexed: credited interest follows a market index, limited by the contract's terms. With a 75% participation rate and a 10% index gain, the contract credits 7.5%. A cap is the most the contract can earn in a period, and index gains usually leave out dividends.
Tax points
- Exchanging a life policy for an annuity is tax-free under section 1035 of the tax code.
- Holding a variable annuity inside an IRA adds no tax advantage beyond the IRA's own, a point the SEC makes in its investor bulletin.
Selling annuities
Variable annuities are securities as well as insurance, so selling them takes a securities registration along with the insurance license. Some states, such as California, also require annuity training before a producer sells any annuity; check your state's rules.