BUYER’S
GUIDE TO
FIXED DEFERRED ANNUITIES
Prepared by the National Association of Insurance
Commissioners
The
National Association of Insurance Commissioners is an association of state
insurance regulatory officials. This association helps the various insurance
departments to coordinate insurance laws for the benefit of all consumers.
This guide does
not endorse any company or policy.
It
is important that you understand the differences among various annuities so
you can choose the kind that best fits your needs. This guide focuses on fixed deferred annuity contracts. There is, however, a brief
description of variable annuities. If you’re thinking of buying an
equity-indexed annuity, an appendix to this guide will give you specific
information. This Guide isn’t meant
to offer legal, financial or tax advice. You may want to consult independent
advisors. At the end of this Guide are questions you should ask your agent
or the company. Make sure you’re satisfied with the answers before you
buy.
WHAT IS AN ANNUITY?
An
annuity is a contract in which an insurance company makes a series of income
payments at regular intervals in return for a premium or premiums you have
paid. Annuities are most often bought for future retirement income. Only an
annuity can pay an income that can be guaranteed to last as long as you
live.
An
annuity is neither a life insurance nor a health insurance policy. It’s
not a savings account or a savings certificate. You shouldn’t buy an
annuity to reach short-term financial goals.
Your
value in an annuity contract is the premiums you’ve paid, less any
applicable charges, plus interest credited. The insurance company uses the
value to figure the amount of most of the benefits that you can choose to
receive from an annuity contract. This guide explains how interest is
credited as well as some typical charges and benefits of annuity contracts.
A
deferred annuity has two parts or periods. During the accumulation
period, the money you put into the annuity, less any applicable charges,
earns interest. The earnings grow tax-deferred as long as you leave them in
the annuity. During the second
period, called the payout period,
the company pays income to you
or to someone you choose.
WHAT ARE THE DIFFERENT KINDS OF ANNUITIES?
This guide explains major differences in different
kinds of annuities to help you understand how each might meet your needs.
But look at the specific terms of an individual contract you’re
considering and the disclosure document you receive. If your annuity is
being used to fund or provide benefits under a pension plan, the benefits
you get will depend on the terms of the plan. Contact your pension plan
administrator for information.
This
Buyer’s Guide will focus on individual fixed deferred annuities.
Single
Premium or Multiple Premium
You
pay the insurance company only one payment for a single
premium annuity. You make a series of payments for a multiple premium annuity. There are two kinds of multiple premium
annuities. One kind is a flexible
premium contract. Within set limits, you pay as much premium as you
want, whenever you want. In the other kind, a scheduled
premium annuity, the contract spells out
your payments and how often you’ll make them.
Immediate
or Deferred
With
an immediate annuity, income
payments start no later than one year after you pay the premium. You usually
pay for an immediate annuity with one payment.
The
income payments from a deferred annuity
often start many years later. Deferred annuities have an accumulation
period, which is the time between when you start paying premiums and when
income payments start.
Fixed
or Variable
·
Fixed
During
the accumulation period of a fixed
deferred annuity, your money (less any applicable charges) earns
interest at rates set by the insurance company or in a way spelled out in
the annuity contract. The company guarantees that it will pay no less than a
minimum rate of interest. During the payout period, the amount of each
income payment to you is generally set when the payments start and will not
change.
·
Variable
During the accumulation period of a variable
annuity, the insurance company puts your premiums (less any applicable
charges) into a separate account. You decide how the company will invest
those premiums, depending on how much risk you want to take. You may put
your premium into a stock, bond or other account, with no guarantees, or
into a fixed account, with a minimum guaranteed interest. During the payout
period of a variable annuity, the amount of each income payment to you may
be fixed (set at the beginning) or variable (changing with the value of the
investments in the separate account).
HOW ARE THE INTEREST RATES SET FOR MY FIXED
DEFERRED ANNUITY?
During the accumulation period,
your money (less any applicable charges) earns interest at rates that change
from time to time. Usually, what
these rates will be is entirely up to the insurance company.
Current
Interest Rate
The current rate is the rate the company decides to credit to your contract
at a particular time. The
company will guarantee it will not change for some time period.
·
The initial
rate is an interest rate the insurance company may credit for a set
period of time after you first buy your annuity. The initial rate in some
contracts may be higher than it will be later. This is
often called a bonus rate.
·
The renewal
rate is the rate credited by the company after the end of the set time
period. The contract tells how the company will set the renewal rate, which
may be tied to an external reference or index.
Minimum
Guaranteed Rate
The
minimum guaranteed interest rate is
the lowest rate your annuity will earn. This rate is stated in the contract.
Multiple
Interest Rates
Some
annuity contracts apply different interest rates to each premium you pay or
to premiums you pay during different time periods.
Other
annuity contracts may have two or more accumulated values that fund
different benefit options. These accumulated values may use different
interest rates. You get only one of
the accumulated values depending on which benefit you choose.
WHAT CHARGES MAY BE SUBTRACTED FROM MY FIXED DEFERRED
ANNUITY?
Most
annuities have charges related to the cost of selling or servicing it. These
charges may be subtracted directly from the contract value. Ask your agent
or the company to describe the charges that apply to your annuity. Some
examples of charges, fees and taxes are:
Surrender
or Withdrawal Charges
If
you need access to your money, you may be able to take all or part of the
value out of your annuity at any time during the accumulation period. If you
take out part of the value, you may pay a withdrawal
charge. If you take out all of the value and surrender, or terminate, the
annuity, you may pay a surrender
charge. In either case, the company may figure the charge as a percentage of
the value of the contract, of the premiums you’ve paid or of the amount
you’re withdrawing. The company may reduce or even eliminate the surrender
charge after you’ve had the contract for a stated number of years. A
company may waive the surrender charge when it pays a death benefit.
Some
annuities have stated terms. When the term is up, the contract may
automatically expire or renew. You’re usually given a short period of
time, called a window, to decide
if you want to renew or surrender the annuity. If you surrender during the
window, you won’t have to pay surrender charges. If you renew, the
surrender or withdrawal charges may start over.
In
some annuities, there is no charge if you surrender your contract when the
company’s current interest rate falls below a certain level. This may be
called a bail-out option.
In
a multiple-premium annuity, the surrender charge may apply to each premium
paid for a certain period of time. This may be called a rolling surrender or withdrawal charge.
Some
annuity contracts have a market value
adjustment feature. If interest rates are different when you surrender
your annuity than when you bought it, a market value adjustment may make the
cash surrender value higher or lower. Since you and the insurance company
share this risk, an annuity with a MVA feature may credit a higher rate than
an annuity without that feature.
Be
sure to read the Tax Treatment section and ask your tax advisor for
information about possible tax penalties on withdrawals.
Free
Withdrawal
Your
annuity may have a limited free
withdrawal feature. That lets you make one or more withdrawals without a
charge. The size of the free withdrawal is often limited to a set percentage
of your contract value. If you make a larger withdrawal, you may pay
withdrawal charges. You may lose any interest above the minimum guaranteed
rate on the amount withdrawn. Some annuities waive withdrawal charges in
certain situations, such as death, confinement in a nursing home or terminal
illness.
Contract
Fee
A
contract fee
is a flat dollar amount charged either once or annually.
Transaction
Fee
A
transaction fee is a charge per premium payment or other transaction.
Percentage
of Premium Charge
A
percentage of premium charge is a charge deducted from each premium paid.
The percentage may be lower after the contract has been in force for a
certain number of years or after total premiums paid have reached a certain
amount.
Premium Tax
Some
states charge a tax on annuities. The insurance company pays this tax to the
state. The company may subtract the amount of the tax when you pay your
premium, when you withdraw your contract value, when you start to receive
income payments or when it pays a death benefit to your beneficiary.
WHAT ARE SOME FIXED DEFERRED ANNUITY
CONTRACT BENEFITS?
Annuity Income Payments
One
of the most important benefits of deferred annuities is your ability to use
the value built up during the accumulation period to give you a lump sum
payment or to make income payments during the payout period. Income payments
are usually made monthly but you may choose to receive them less often. The
size of income payments is based on the accumulated value in your annuity
and the annuity’s benefit rate
in effect when income payments start. The benefit rate usually depends on
your age and sex, and the annuity payment option you choose. For example,
you might choose payments that continue as long as you live, as long as your
spouse lives or for a set number of years.
There
is a table of guaranteed benefit rates in each annuity contract. Most
companies have current benefit
rates as well. The company can change the current rates at any time, but the
current rates can never be less than the guaranteed benefit rates. When
income payments start, the insurance company generally uses the benefit rate
in effect at that time to figure the amount of your income payment.
Companies
may offer various income payment options. You (the owner) or another person
that you name may choose the option. The options are described here as if
the payments are made to you.
·
Life Only - The company pays income for your lifetime. It doesn’t make
any payments to anyone after you die. This payment option usually pays the
highest income possible. You might choose it if you have no dependents, if
you have taken care of them through other means or if the dependents have
enough income of their own.
·
Life Annuity with Period Certain - The company pays income for as long
as you live and guarantees to make payments for a set number of years even
if you die. This period certain
is usually 10 or 20 years. If you live longer than the period certain,
you’ll continue to receive payments until you die. If you die during the
period certain, your beneficiary gets regular payments for the rest of
that period. If you die after the period certain, your beneficiary
doesn’t receive any payments from your annuity. Because the “period
certain” is an added benefit, each income payment will be smaller than
in a life-only option.
·
Joint and Survivor - The company pays income as long as either you or
your beneficiary lives. You may choose to decrease the amount of the
payments after the first death. You may also be able to choose to have
payments continue for a set length of time. Because the survivor
feature is an added benefit, each income payment is smaller than in a
life-only option.
Death Benefit
In some annuity contracts, the company may pay a
death benefit to your beneficiary if you die before the income payments
start. The most common death benefit is the contract value or the premiums
paid, whichever is more.
Can My Annuity’s VALUE BE
DIFFERENT DEPENDING ON MY CHOICE OF Benefit?
While all deferred annuities
offer a choice of benefits, some use different accumulated values to pay
different benefits. For example, an annuity may use one value if annuity
payments are for retirement benefits and a different value if the annuity is
surrendered. As another example, an annuity may use one value for long-term
care benefits and a different value if the annuity is surrendered. You
can’t receive more than one benefit at the same time.
WHAT ABOUT THE TAX TREATMENT OF ANNUITIES?
Below is a general discussion about taxes and
annuities. You should consult a professional tax advisor to discuss your
individual tax situation.
Under current federal law, annuities receive
special tax treatment. Income tax on annuities is deferred, which means you
aren’t taxed on the interest your money earns while it stays in the
annuity. Tax-deferred accumulation isn’t the same as tax-free
accumulation. An advantage of tax deferral is that the tax bracket you’re
in when you receive annuity income payments may be lower than the one
you’re in during the accumulation period. You’ll also be earning
interest on the amount you would have paid in taxes during the accumulation
period. Most states’ tax laws on
annuities follow the federal law.
Part
of the payments you receive from an annuity will be considered as a return
of the premium you’ve paid. You won’t have to pay taxes on that part.
Another part of the payments is considered interest you’ve earned. You
must pay taxes on the part that is considered interest when you withdraw the
money. You may also have to pay a 10% tax penalty if you withdraw the
accumulation before age 59 1/2. The Internal Revenue Code also has rules
about distributions after the death of a contract holder.
Annuities
used to fund certain employee pension benefit plans (those under Internal
Revenue Code Sections 401(a), 401(k), 403(b), 457 or 414) defer taxes on
plan contributions as well as on interest or investment income. Within the
limits set by the law, you can use pretax dollars to make payments to the
annuity. When you take money out, it will be taxed.
You
can also use annuities to fund traditional and Roth IRAs under Internal
Revenue Code Section 408. If you buy an annuity to fund an IRA, you’ll
receive a disclosure statement describing the tax treatment.
WHAT IS A “FREE LOOK” PROVISION?
Many
states have laws which give you a set number of days to look at the annuity
contract after you buy it. If you decide during that time that you don’t
want the annuity, you can return the contract and get all your money back.
This is often referred to as a free
look or right to return period. The free look period should be prominently
stated in your contract. Be sure to read your contract carefully during the
free look period.
HOW DO I KNOW IF A FIXED DEFERRED ANNUITY IS RIGHT FOR
ME?
The
questions listed below may help you decide which type of annuity, if any,
meets your retirement planning and financial needs. You should think about
what your goals are for the money you may put into the annuity. You need to
think about how much risk you’re willing to take with the money. Ask
yourself:
· How much retirement income will I need in addition to what I will get
from Social Security and my pension?
· Will I need that additional income only for myself or for myself and
someone else?
· How long can I leave my money in the annuity?
· When will I need income payments?
· Does the annuity let me get money when I need it?
· Do I want a fixed annuity
with a guaranteed interest rate and little or no risk of losing the
principal?
· Do I want a variable annuity with the potential for higher earnings that
aren’t guaranteed and the possibility that I may risk losing principal?
· Or, am I somewhere in between and willing to take some risks with an
equity-indexed annuity?
WHAT
QUESTIONS SHOULD I ASK MY AGENT OR THE COMPANY?
·
Is this a single premium or multiple premium contract?
·
Is this an equity-indexed annuity?
·
What is the initial interest rate and how long is it guaranteed?
·
Does the initial rate include a bonus rate and how much is the bonus?
·
What is the guaranteed minimum interest rate?
·
What renewal rate is the company crediting on annuity contracts of the
same
type that were issued last year?
·
Are there withdrawal or surrender charges or penalties if I want to end
my
contract early and take out all of my money? How much are they?
·
Can I get a partial withdrawal without paying surrender or other charges
or
losing interest?
·
Does my annuity waive withdrawal charges for reasons such as death,
confinement in a nursing home or terminal illness?
·
Is there a market value adjustment (MVA) provision in my annuity?
·
What other charges, if any, may be deducted from my premium or contract
value?
·
If I pick a shorter or longer payout period or surrender the annuity,
will the
accumulated value or the way interest is credited change?
·
Is there a death benefit? How
is it set? Can it change?
·
What income payment options can I choose? Once I choose a payment
option, can I change it?
FINAL POINTS TO CONSIDER
Before
you decide to buy an annuity, you should review the contract. Terms and
conditions of each annuity contract will vary.
Ask
yourself if, depending on your needs or age, this annuity is right for you.
Taking money out of an annuity may mean you must pay taxes. Also, while
it’s sometimes possible to transfer the value of an older annuity into a
new annuity, the new annuity may have a new schedule of charges that could
mean new expenses you must pay directly or indirectly.
You
should understand the long-term nature of your purchase. Be sure you plan to
keep an annuity long enough so that the charges don’t take too much of the
money you put in. Be sure you understand the effect of all charges.
If
you’re buying an annuity to fund an IRA or other tax-deferred retirement
program, be sure that you’re eligible. Also, ask if there are any
restrictions connected with the program.
Remember
that the quality of service that you can expect from the company and the
agent is a very important factor in your decision.
When
you receive your annuity contract, READ
IT CAREFULLY!! Ask the
agent and company for an explanation of anything you don’t understand. Do
this before any free look period
ends.
Compare
information for similar contracts from several companies. Comparing products
may help you make a better decision.
If
you have a specific question or can’t get answers you need from the agent
or company, contact your state insurance department at 801-538-3066, email life.uid@utah.gov.
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