At its most basic level, an annuity is a contract setting up a relationship whereby an individual or group invests money with an insurance company for investment purposes with the expectation that the money will be returned in a lump sum, or in a number of payments over a period of time. That income stream might be needed immediately if personal savings, Social Security checks and other sources of funds do not adequately cover a retired individual�s expenses, or it might be one component of a working person�s multi-faceted, long-term retirement strategy.
The modern annuity initially became a popular financial
product in the
Particularly since the 1980s, several factors have instigated major surges in annuity sales figures, with dollars spent annually on annuities consistently amounting to several billions of dollars. In the past, many working Americans could count on receiving consistent income through their employers� pension plans upon retirement, but these plans have become less prominent in the modern business world, and the emphasis on retirement planning has shifted toward investments in 401(k) plans and Individual Retirement Accounts (IRAs). Meanwhile, legislators and other government officials have had heated debates concerning the future of our country�s Social Security program and its supplemental payouts to senior citizens. Faced with potentially non-existent or reduced retirement benefits from these traditional sources, many consumers, insurance producers and financial planners now view the annuity as a monetary cushion that can either be layered on top of pensions and Social Security benefits or serve as a substitute for one of the two.
Even with pension plans and
Social Security in place, the retirees of today and tomorrow must cope with one
tradeoff related to the positive advances made in science and modern medicine.
They will live longer than their relatives from previous generations, but their
greater life expectancies might be greater than the assets they set aside for
their years out of the workforce. Although seniors probably expect to gradually
spend down their nest egg as they advance in age, their longevity could exceed
their expectations by 5, 10, 15 or even 20 years and lead to the shattering of that
egg with plenty of time left on their body clocks. With this concern in mind,
many people consider an annuity to be the reverse of a life insurance policy.
Whereas life insurance financially supports beneficiaries if someone dies too
soon to support their family, an annuity can financially support someone if he
or she lives too long to support his or her self. These longevity issues might
help explain why, according to the Gallup Poll, women, who generally are the
longer-living sex in the
Another factor in the annuity�s rise to prominence is the American public�s increasing interest in financial investments and asset accumulation. For some people, an annuity is more than just a retirement product. It can be a long-term investment option with features that sometimes put it a notch or two above other investment vehicles, regardless of when or how those people plan on spending their money. In many cases, products called �fixed annuities� will guarantee interest rates that exceed those available through certificates of deposit (CDs), and all fixed annuities guarantee a return of the money that investors put into them. This money is called the �principal.� Products called �variable annuities� are less likely to guarantee a return of principal, but they have the power to produce even greater investment gains, like those returns available through mutual funds or the stock market.
Long-term investors and long-term savers are also sometimes won over by the annuity�s tax features. Most annuities go through an �accumulation period� and a �payout period.� During the accumulation period, the owner�s account is left untouched for growth purposes. In the payout period, accumulated money is disbursed, either in a lump sum or in pieces. Throughout the accumulation period, interest or investment gains earned on an annuity grow on a tax-deferred basis, and the interest may be compounded. So, in simplistic terms, no one pays taxes on the money until it comes out of the account, and interest can be credited to both the principal and any previously earned interest. Consumers receive these positive benefits in exchange for less liquidity than they might find in CDs, mutual funds or other financial options.
The consumer-driven interest in annuities has coincided with and been nurtured by an increase in the number of people who sell the products. Despite being insurance contracts underwritten by insurance companies, annuities eventually found favor among stockbrokers who could use personal investment experience to explain the contracts� complexities to common shoppers. Banks have also become major players in the annuity game over the past 15 years, sometimes selling the contracts for insurance companies and sometimes going one step further and managing customers� annuity accounts.
The partnerships and the competition within the annuity industry present challenges to the insurance professional. Each new product can differ from its predecessors in obvious or subtly important ways, making expert advice an integral part of overall customer satisfaction and forcing the professional to remain knowledgeable about the latest product features. Even long-time industry professionals are looking at the modern annuity and acknowledging that it is one of the most confusing kinds of financial products available for purchase and that sellers with respectable knowledge and good intentions can still be misinformed about some of the details found in annuity contracts. If readers examine 20 different equity-indexed annuities, they might realize that none of the 20 products calculate the consumer�s interest in exactly the same manner. Even the two basic kinds of annuities�the fixed and variable varieties�often get lumped together to the point where buyers do not understand the risks, benefits and fees associated with each of these products. Overly simplistic comparisons between fixed annuities and CDs or between variable annuities and mutual funds sometimes leave out important contrasts pertaining to liquidity, beneficiary issues and more. Riders and various bells and whistles are occasionally under-emphasized to people who could benefit from them the most and oversold to people who need them the least.
Whether the media�s overgeneralizations, an occasionally misinformed sales force or overly aggressive sales pitches are to blame, today�s insurance regulators worry that annuities are sold too frequently to too many people who do not benefit from them. According to a report by the Los Angeles Times, the National Association of Securities Dealers filed a record 88 enforcement actions related to annuities from November 2004 through November 2005. Both before and after that report, consumer advocates and financial institutions realized that simply receiving state approval to sell a particular annuity might not be enough to remove any deserved or undeserved public relations problems that have attached themselves to some of these products.
The insurance industry has either debated or implemented various measures in recent years in attempts to bring down the number of dissatisfied annuity owners who have felt like victims of bad advice. These proposed or implemented measures include requiring in-house training for insurance producers who want to sell a specific annuity, requiring that a third party evaluate a product�s suitability for a client before the insurer may finalize a sale and including more-detailed disclosures in application forms, contracts and prospectuses that force potential buyers to acknowledge their understanding of such important annuity elements as surrender charges, annual fees and guarantees of principal and interest.
Some states, including
Almost every annuity can be categorized in three different ways, depending on how the corresponding funds are invested, how the owner pays for the annuity and when the owner expects to dip into the annuity for payments. An annuity may be either fixed or variable, deferred or immediate, and bought with either a lump sum or in multiple installments. We will now briefly review these three basic groupings and examine how they relate to consumers� risk tolerances and financial goals.
Industry reports consistently reveal that people�s affections shift from the fixed annuity to the variable annuity and back again as the economy alternates between good times and bad. �Fixed annuities� experience gains in popularity when the stock market dips or goes through volatile periods.
Regardless of market fluctuations, people who care more about saving money than engaging in high-risk, high-return ventures tend to prefer fixed annuities over variable annuities because fixed contracts contain fiscal guarantees. The traditional fixed annuity guarantees a return of all money given to the insurance company and also credits interest to a person�s account. The insurer usually promises minimum annual returns. During the early part of the 21st century, these returns have typically been near 3 percent or 4 percent, though contractually guaranteed rates have often been above those numbers during an annuity�s first few years. The risk to the fixed annuity purchaser is minimal because the insurance company invests the client�s premiums in conservative, long-term bonds. The consumer is responsible for picking the right contract and insurer, while the insurer is responsible for investing the principal in a manner that will satisfy the contractual guarantees.
�Variable annuities� increase in popularity when the financial markets are noticeably strong. They appeal to investors who are willing to risk losing some or all of their principal if the insurance company gives them opportunities for significant returns.
Variable annuities feature few or no guarantees, but the interest credited to them can greatly exceed the returns promised in fixed contracts. The owner shoulders the responsibility of investing his or her money in one or several mutual funds made available to the insurer�s clientele, and the annuity�s account balance will go up or down based on the funds� performances. In addition to absorbing market risks, variable annuity owners must pay various fees, typically on an annual basis, that do not factor into fixed annuity purchases.
Many people try to balance their portfolios by purchasing fixed annuities and variable annuities. Others buy only one of the two and base their choice on the kinds of financial assets they already possess.
Deferred and Immediate Annuities
The annuity shopper�s choice between an immediate or deferred annuity will depend on when the person prefers to receive payments from the insurance company. Most of the annuities sold today are deferred. A �deferred annuity� serves clients who do not need consistent, additional income at the time of purchase but envision needing the money years into the future. Deferred annuities go through an accumulation period, during which the owner�s account is expected to grow without negatively affecting the person�s tax situation. When people buy a deferred annuity, their goal at that moment is to watch their principal expand for several years. Presumably at a much later date, they will cash in their deferred annuity for a lump-sum payout or for divided payouts that will be disbursed throughout someone�s remaining lifetime. Clients must wait at least one year before they may begin receiving regularly scheduled payouts through a deferred annuity.
According to the financial trade publication American Banker, less than 5 percent of the annuities sold in 2000 were immediate. An �immediate annuity� creates an income stream for the owner soon after the sale date. In general, the owner starts receiving payouts within one year of entering into the contract, and most immediate annuities can put money into a person�s pocket within 30 days. These products do not go through a traditional accumulation period because the money is being taken out of them at the same time that the principal is growing in value. Opportunities for tax deferral with an immediate annuity are relatively minimal because taxation on any annuity always begins at the same time as the payouts. This is because the annuity payout must always include any taxable earned interest before non taxable principal.
People who buy immediate annuities might care less about growing their principal and more about maintaining their current income level for as long as possible. An immediate annuity can help them achieve their goals by giving them payouts on a monthly, annual or other set schedule rather than in a lump sum.
The amount of money a client receives regularly from an immediate annuity will be determined by the principal, the owner�s life expectancy and the fixed or variable status of the annuity. With all other factors being equal, a larger principal will translate to bigger immediate payouts because the insurance company will have more money to give out in the first place. But, because annuities are designed as supplementary sources of income that last a lifetime, immediate payouts offered to a younger person can be lower than those offered to an older person, even if the younger individual invests more principal. Immediate annuity shoppers who have significant health problems might be able to secure higher payouts if they seek out an annuity provider who engages in substantive medical underwriting.
Since the insurance company begins paying money to the immediate annuity client so soon, the buyer may have a hard time getting out of the contract with much principal intact. Immediate annuities that grant the owner greater access to principal in the event of a financial emergency or a mere change of heart force the customer to receive considerably lower payouts. Also, because the standard annuity death benefit calls for heirs to receive either a return of any remaining principal or the value of the deceased�s account, death benefits in an immediate annuity (if they are available at all) are likely to decline more quickly than death benefits in a fixed annuity of initially equal value.
Most immediate annuities are fixed products, allowing owners to operate on a budget and know that their scheduled payouts will not dip below a guaranteed minimum dollar amount calculated by the insurance company. However, because immediate fixed annuities lock the owner into a room where the ceiling on interest rates is only so high, some people worry that these products will not keep up with inflation and that they will create situations in which consumers will need to gradually lower their standard of living in order to make ends meet. In efforts to confront these concerns, insurance companies have designed some riders (add-on features in insurance contracts) that can automatically increase annuity payouts every year by a few percentage points or can at least ensure that payouts will temporarily keep pace with consumer price indexes.
A minority of annuity owners choose to receive variable immediate payouts, which can combat inflation without the help of a rider. Variable immediate annuities will not help someone craft a budget because, without riders, they offer no minimum guarantees. The insurance company calculates an initial payout for a variable immediate annuity, based on life expectancy and the current economy, but subsequent payouts can rise or fall in direct relation to the investment performance of the variable accounts. Another possible but rarely mentioned option for the annuity prospect is the �split annuity,� which can turn some of the principal into an immediate income stream and put the rest into a deferred account for tax-free, long-term accumulation.
Single Premiums and Multiple Premiums
Before the market became flooded with incredibly diverse and intricate products, many annuities were purchased in pieces. The buyer would periodically make level payments to an insurance company and hope that the accumulating funds would ultimately add up to a decent amount when the time came for retirement. Policies set up in this way still exist, but the common level-premium contracts of the past have been joined by annuities that consumers can fund through one lump sum or through unequal periodic payments.
Individuals who purchase annuities outside their workplaces are probably buying these products with a single premium. Buying a deferred annuity with a large, single premium allows for quicker, substantive interest growth, and finding an immediate annuity that does not require a lump-sum payment can seem impossible in some markets. In order to convince buyers to commit more money up front, insurance companies might sweeten contracts by increasing initial and guaranteed minimum interest rates for single-premium fixed annuities and by reducing various fees for single-premium variable annuities.
Annuity contracts that allow for multiple, flexible premium payments are nearly exclusive to deferred annuities. Flexible-premium annuity contracts can stipulate a specific pay schedule as chosen by the buyer or the insurer, or the insurance company might give customers the freedom to make contributions to their accounts at times that are not pre-determined. The contract might also state that the buyer can make unlimited contributions to the account but that all premiums must meet or exceed a minimum value. Many multiple-premium annuities are part of employer-sponsored retirement plans funded by regular payroll deductions.
Premium Requirements and Client Eligibility
In general, an initial lump-sum premium for a fixed annuity will amount to at least $1,000, and multiple-premium contributions may be as low as $25 each. Insurance companies will sometimes let people put less money into an annuity up front if the owners agree to not withdraw funds for several years and to receive eventual payouts periodically rather than in a lump sum.
An annuity contract that allows owners to invest very little money might appeal to people in search of a deferred annuity because the small initial investment can grow substantially over time if it goes untouched. However, some financial experts question the benefits of putting only a small amount of money into an immediate annuity. After all, that small amount will need to be divided right away, before it can grow much at all, and the size of the payouts might not end up satisfying a client�s financial needs.
In most cases, the federal government does not put a cap on the amount of money someone may invest in an annuity. This freedom distinguishes the annuity from other retirement vehicles, including 401(k) plans and IRAs, which limit annual contributions to a few thousand dollars. Occasionally, larger investments will help improve the terms of an annuity contract, with insurers upping interest-rate guarantees for people with larger accounts. Yet, the sky is not always the limit in regard to a client�s chosen investment amount. Even though laws might not prevent big annuity investments, individual insurers can set maximum limits. For example, an insurance company might at least take additional, precautionary steps before approving the sale of an annuity for more than $500,000 due to the large dollar amount of the risk.
Also, some situations might arise in which all the money in the world will not be enough for someone to get his or her hands on a particular annuity. Like life insurance policies, annuities usually feature maximum issue ages. The �issue age� is the age of the annuitant (the recipient of payouts) when the contract goes into effect. In the past, it was customary for insurance companies to not sell annuities to people who were at least 70 or 75 years old. But, perhaps because people are living longer these days, many of today�s insurers have increased their maximum issue ages to 80, 85 or 90. A few annuity products do not feature a maximum issue age.
From a consumer�s perspective, issue age restrictions reinforce the idea that a retirement product is not suitable for all retired persons. If a customer is approaching his or her life expectancy or has already surpassed it, a deferred annuity might not grow fast enough for the person to benefit adequately from the product. In addition, both deferred and immediate annuities can severely limit the buyer�s access to the principal and can create financial problems for someone going through a health crisis.
The liquidity concern might also make an annuity unsuitable for most young people and many middle-aged individuals, as they do their best to pay for housing, education, transportation and other important items or necessities. Consumers might indeed have good reasons to buy an annuity during their lifetime, but they could put themselves in an undesirable position by waiting too long or agreeing too quickly to put their money into this kind of account.
Parties in an Annuity Contract
No matter who sells the product or how the seller has organized it, an annuity is a legal agreement that bestows rewards and responsibilities upon multiple parties. These parties include the insurance company, the annuity owner, the annuitant and the beneficiary.
The insurance company behind the annuity has a contractual obligation to eventually pay money to a person or other entity. In return, the insurer collects fees from investors or is allowed to invest clients� money and keep a portion of any positive yields.
The �annuity owner� is the person who puts money into the annuity. He or she chooses how much to invest and, in the case of variable annuities, how that investment amount should be allocated among various funds. The annuity owner has many of the same rights as the owner of a life insurance policy. The owner can surrender the contract, choose a beneficiary and, in some cases, borrow money from the annuity�s cash value. The owner hangs onto these rights until the contract expires or is terminated. An annuity may be owned by one person, several people, a trust, a corporation, any adult or a minor in conjunction with a legal guardian.
An annuity owner also gets to designate an �annuitant,� who receives the income created through the annuity. Issue ages pertain to the annuitant�s age at the beginning of the contract, and it is the annuitant who must pass away before the insurance company will pay any death benefits to survivors. Because annuity payouts are determined, in part, by life expectancy, an annuitant must be a person, rather than a trust or corporation.
In most cases, the annuity owner and the annuitant will be the same person. In other words, people will invest their own money and plan on creating an income stream for themselves. However, one person can own an annuity and choose another person as the annuitant. For example, one spouse might own an annuity that pays income to the other spouse, or a company might own an annuity that pays income to a former employee. Along with the owner, the annuitant must sign an annuity application and give identifying information to the insurance company.
The annuitant lacks the right to borrow money from the annuity, alter investments within the annuity or partake in any of the previously mentioned privileges that are granted to the annuity owner. In fact, the owner may even eliminate an annuitant from the original contract and choose a new person who will be eligible for payouts. In order for this to occur, the new annuitant needs to have been alive when the owner entered into the initial agreement with the insurance company.
The �beneficiary� is a person, corporation or trust that receives death benefits if the annuitant passes away before income payouts begin. Depending on the annuity, a beneficiary might also be entitled to benefits even if the annuitant had already begun receiving annuity income before death. The annuity owner chooses the beneficiary and can alter that choice after the annuity has been issued. As is the case with a life insurance policy, owners can designate multiple beneficiaries, divide death benefits equally or unequally among those multiple beneficiaries, list contingent beneficiaries or pick themselves as beneficiaries. If the owner and the beneficiary are different people, the beneficiary cannot borrow from the annuity, alter investments within the annuity or partake in any of the other previously mentioned privileges that are granted to the annuity owner.
If an annuity owner is ready for the insurance company to begin paying an income stream to the annuitant, the �annuitization� process will commence. During traditional annuitization, the insurance company pays out the same amount in installments on a set schedule to an annuitant. An assortment of newer annuity contracts allows the annuitant to opt for payouts that are scheduled to go up or down after a certain date. This option can be helpful if the annuitant foresees a significant change in the need for income. For example, the scheduled conclusion of a mortgage agreement might be reason enough for the annuitant to want payouts that start large and drop a bit after a certain date. Some variable contracts allow the annuitant to choose between receiving level payouts upon annuitization or payouts that will go up or down depending on market performance.
In most annuitization situations, payouts are fixed at an equal amount and are scheduled to continue throughout the annuitant�s lifetime. When the annuitant chooses this option, the amount of each individual payout owed to the person will depend on the account balance and a figure called the �benefit rate.� The benefit rate is the dollar amount the insurer will pay in each installment (usually on a monthly basis) for every $1,000 in the annuity account. The benefit rates offered by different insurance companies will vary, but all benefit rates will be based, to a large extent, on the annuitant�s life expectancy. Payouts from most immediate annuities will reflect the benefit rate that was offered by the insurer when the annuity contract was signed. Payouts for most deferred annuities will be based on either the benefit rate offered by the insurer at the time of annuitization or the guaranteed minimum benefit rate that was offered by the insurer when the contract was signed.
With life expectancy serving as such an important factor in the calculation of benefit rates, it ought to come as no surprise to the reader that older people receive higher benefit rates than younger people and that men receive higher benefit rates than women of the same age. As was mentioned previously, some insurers will increase their benefit rates for annuitants with serious health problems.
Once annuitization has begun, the insurer generally may not reduce the benefit rate. Suppose, for example, that a client bought an annuity and annuitized the account for life when it was worth $100,000 at a benefit rate of $10 per thousand. The client would be entitled to $1,000 each month for life. Technically, the client�s account balance, based on that benefit rate, could drop to zero after 100 months, but the insurer would need to continue the same payments even if the annuitant lived longer than that. Once again, the reader should note that the risk to insurers who sell annuities differs from the risk to insurers who sell life policies. For the life insurer, the risk is that the person will die too soon to make the company profitable. For the annuity issuer, the risk is that a person will die too late to make the company profitable.
Very often, people use the term �annuitization� as if it was synonymous solely with lifetime, monthly income. In fact, modern annuitization involves several other options for the annuitant. Instead of occurring monthly, lifetime payouts can go to the annuitant every year, every season, twice each year or on a different schedule. Or the payout schedule might not be linked to the annuitant�s lifetime at all. In some rare cases, payouts might be set to continue regularly until the insurer has given a specific, cumulative dollar amount to the annuitant. A �period certain annuity� (which should not be confused with a �life with period certain annuity�) pays money to the annuitant only until a predetermined date, even if the person is still alive after that date.
The choice of when and how to annuitize one�s money rests with the annuity owner. The owner can annuitize before leaving the workforce, upon reaching retirement age or much later in life. The government treats annuities differently than it treats 401(k) plans and IRAs, and the owner generally does not need to begin annuitizing after his or her 70th birthday. Despite the absence of a federal requirement, most annuity contracts call for some level of annuitization by the time the annuitant�s age hits 85. Many people begin annuitization by only taking money out of the interest portion of their account and leaving their principal intact. The annuity owner is usually not required to make decisions related to annuitization when applying for a contract, but some insurance companies will boost interest rates on fixed annuities if the buyer agrees to eventually annuitize rather than opt for a lump-sum settlement at a later date.
The promise of a lifelong income stream is not always enough to make the owner choose annuitization. Obviously, an investor who does not yet need additional income might be best served by leaving funds alone and allowing them to grow on a tax-deferred basis. But on a contractual level, the risks involved with annuitization are more complex than that and involve liquidity, inflation protection and death benefits.
Some people don�t annuitize because they like the flexibility that comes with receiving a lump-sum settlement from an insurer after a period of surrender charges has expired. Whereas an annuity that is still in the accumulation period can be surrendered for the full principal amount, minus surrender charges, a contract that has reached the annuitization period is nearly unbreakable. Many annuitized products can only be surrendered in pieces, with withdrawals perhaps needing to meet maximum and minimum requirements.
Once the owner annuitizes, the amount of each payout is generally locked in place for the rest of the annuitant�s life. So, if inflation or other factors cause an eventual rise in the annuitant�s living expenses, the person will need to look beyond the annuity income to make up the difference. Some insurers offer inflation riders that might boost payouts at a steady rate or increase them at specified times. Unfortunately for the annuitant, these riders typically lower the benefit rate that the insurer would normally offer at the beginning of annuitization, and they can represent an unnecessary expense when the annuitant has a low life expectancy.
People who annuitize for life should plan to have mortality on their side because, once annuitization begins, the beneficiary�s opportunity to collect death benefits often disappears. The standard annuity death benefit gives beneficiaries the greater of the principal and the account balance when the annuitant passes away, yet the death benefit usually applies only if the death occurs during the accumulation period. If someone annuitizes an account worth $200,000 for a lifetime monthly income of $2,000 and dies two months later, the insurer might be able to pocket the remaining $196,000 in the deceased�s account. The owner can solve part of this potential problem by requesting enhanced death benefits, but, like inflation protection, extra security for the beneficiary will reduce payouts for the annuitant.
Tax breaks constitute one of the most significant reasons why annuity sales have been so fruitful over the past few decades. At this point, we will look at the relationship between the federal tax code and annuities and will cover some of the positive and negative tax consequences that prospective buyers should know about before they sign on an insurer�s dotted line. The reader should understand that the material presented here is intended only to summarize an annuity's potential tax features. Specific questions about how the Internal Revenue Service (IRS) might interpret an individual�s tax situation should always be referred to a professional with substantial background and knowledge of the applicable tax law.
Like an IRA, an annuity represents one of the few financial products available today that allows investors to accumulate money and temporarily avoid paying taxes on investment gains. This opportunity for tax deferral does not make an annuity tax-free or tax-deductible. The annuitant merely has the choice to wait awhile before paying certain taxes to the government.
On a federal level, an annuity generates no tax bills until the annuitant receives a payout. If a deferred annuity goes untouched, the annuitant will encounter no tax penalties during the accumulation period. If the owner makes a partial withdrawal from a deferred annuity but does not annuitize the funds, he or she will only pay taxes on the withdrawal, and the money left over in the annuity will continue to grow on a tax-deferred basis. Fixed immediate annuities are poor vehicles for tax deferral because payouts begin right away, and some of that money is automatically treated as taxable income.
Occasionally, federal leaders have proposed eliminating tax deferral benefits for the annuity-buying public. Some of these proposals, including many dating back to the 1980s, eventually became part of federal tax law and will be addressed later in this material. Others�including a proposal to eliminate tax deferral benefits for owners who choose to surrender their annuities in exchange for a lump sum�have failed to gain adequate support in Congress, thereby allowing the annuity to maintain one of its most attractive features.
Tax deferral benefits at the federal level have not prevented individual states from imposing local taxes on annuity premiums or withdrawals. When these taxes apply, the insurance company will sometimes deduct the corresponding amount directly from the owner�s account.
In general, tax deferral works best in long-term investment vehicles. In regard to tax-deferred annuities, logic suggests that the deferral will last until the annuitant begins receiving payouts while in retirement. Between the time when the owner buys the annuity and the time when payouts begin, the typical annuitant not only expects the deferral to nurture growth in the account. He or she probably also expects to have moved to a lower tax bracket.
Annuity payouts are subjected to income taxes, which can often take away 25 percent to 35 percent of many working people�s annual, taxable income. When people retire, their lack of employment can move them into the lowest tax bracket. While situated in a lower tax bracket, the annuitant will be able to keep more money for personal use. Bear in mind though that the positive aspects of tax deferral will not always be as significant as the annuitant expects. It is possible, if not likely, that a person will retire and remain in a relatively high tax bracket. Even if a wealthy person retires and falls into a slightly lower tax bracket, the insurer�s additional fees, particularly those for variable products, might eat away at the annuity�s value and marginalize the benefits of tax deferral.
The federal tax treatment of an annuity payout will depend on how the owner paid for the contract. Annuities funded through retirement plans for teachers and some workers at non-profit organizations are considered �qualified annuities.� Qualified annuities are paid for with pre-tax dollars, which means that the principal in these accounts was not previously counted as part of the owner�s taxable income. Since the principal was never taxed, annuitants pay taxes on the entirety of their annuity income. Like IRAs and 401(k)s, qualified annuity contracts limit the initial amount of money investors can put into their annuity accounts and require that payouts begin by a specific date, usually by the time the annuitant is 70 � .
�Non-qualified annuities� are funded with after-tax dollars, which means the principal was already counted, in one form or another, as part of the owner�s taxable income. Since the principal was already taxed, annuitants only pay taxes on part of their annuity income. Unlike 401(k)s, IRAs and qualified annuities, non-qualified annuity contracts usually do not limit the amount of money investors may put into their annuity accounts, and they do not need to be annuitized by the time the annuitant reaches age 70 �. The reader should note that the rest of this tax-related material (unless stated otherwise) applies solely to non-qualified annuities.
People who utilize non-qualified annuities are ultimately taxed only on the interest that is applied to their accounts, but the mathematical methods used by the IRS to tax annuity payouts are far from simple. Until the 1980s, annuitants received the principal portion of the annuity before they received any interest payments. So, the annuitant often paid no taxes on the annuity for many years. If a person received $100 a month from an annuity that was purchased for $12,000, that person paid no income taxes on the annuity for 10 years. Then, because the annuitant had received a full return of the principal, any remaining payouts were counted entirely as taxable income.
All of that changed thanks to the Tax Equity and Fiscal Responsibility Act of 1982, which mandated that at least some interest from annuities be included in payouts as soon as annuitization begins. As a result of the act, annuitants now pay some income tax each year on any annuity income they receive. If the owner cancels the contract and receives a lump-sum settlement that exceeds the principal, all income taxes on the annuity will be due in a lump sum. If the owner annuitizes the contract for life, income taxes on the annuity must be paid every year, at least until the annuitant dies.
To determine how much of each annuity payout will be subjected to income taxes, we need to know the principal sum and the total expected return on the annuity. The total expected return on an annuity that pays a fixed monthly income for life can be calculated by multiplying the monthly payout by the annuitant�s remaining life expectancy at the beginning of annuitization.
Suppose, for example, that someone annuitizes with a remaining life expectancy of 15 years (180 months) and is set to receive $500 each month for life. By multiplying the remaining life expectancy (180 months) by the monthly payout ($500), we learn that the total expected return on the annuity is $90,000. We can now calculate the taxable and non-taxable portion of each monthly payout by dividing the principal sum by the total expected return. Suppose the annuity was purchased with a lump sum of $80,000. By dividing the principal ($80,000) by the total expected return ($90,000), we are left with an answer of roughly 0.89 or 89 percent. This means that roughly 89 percent of each monthly payout (or roughly $445) will not be counted as taxable income and that the remaining 11 percent of each monthly payout (or roughly $55) will be considered taxable income. This will hold true until the cumulative non-taxable income from the annuity equals the principal investment. After that point, 100 percent of each monthly payout would be considered taxable income.
Different calculations are used when a person opts for variable payouts from a variable annuity. Payouts will go up and down with the markets in this scenario, so the insurer cannot calculate a total expected return. Instead, for tax purposes, the insurer can tell the annuitant the annual dollar amount that will not be taxed. This is accomplished by dividing the principal sum by the person�s remaining life expectancy at the beginning of annuitization.
Once again, imagine that a person annuitizes a contract bought for $80,000 and is expected to live an additional 15 years. By dividing the principal ($80,000) by the remaining life expectancy (15 years), we learn that roughly $5,333 will be exempt from income taxes each year. Anything beyond that annual amount will be taxed.
In the cases of both fixed and variable deferred annuities, beneficiaries will need to pay taxes on the difference between the principal investment and the account�s value at the time of the annuitant�s death. Some insurers have sold riders that can help beneficiaries offset these and other tax issues. The cost of these riders might reduce the benefit rate at annuitization, may be deducted on a regular basis from the owner�s account or can be reflected in slightly lower fixed interest rates that are credited to the annuity during the accumulation period.
Some financial experts believe consumers should only buy an annuity if they want the security of a lifetime income. As far as taxes are concerned, these advisers say there are better places for people�s money. One significant tax-related fact that buyers should understand is that regular income tax rates can be significantly larger than the tax rates on the capital gains that people might earn in the stock market or elsewhere. For savers, the annuity�s guarantees might be enough to cancel out this tax disadvantage. For investors, the differences in tax rates might make other aspects of financial planning more attractive than annuities.
Annuity Fees and Surrender Charges
Annuities have come under fire in recent years and prompted some regulatory investigations because consumers have bought the contracts without being adequately aware of the various charges and fees that influence their annuity�s value and may severely limit their access to principal. Annuity owners might face these charges and fees when they purchase the contract, when they make withdrawals from their account or on an annual basis throughout the length of the contract. The various annuity fees might include a one-time or annual contract fee, a transaction fee that reduces the account balance by a set percentage when the owner deposits or withdraws money from the annuity and an annual fee that compensates a financial institution for management of the account.
Insurers will itemize these fees for people who purchase variable annuities, but fixed annuity owners rarely know how much they pay in fees. Instead, the fees they pay are usually bundled together and factored into the interest rates and benefit rates offered by the insurance company. Annuity fees typically either stay the same throughout the term of the contract or go down annually, but they can sometimes rise.
The various fees represent another reason why some financial experts dislike annuities in some situations. Annual fees can consistently lower investment progress in variable annuities, and withdrawal fees can make the interest guarantees in fixed annuities seem small or at least comparable to the guarantees found in similar products (such as CDs) that can offer greater liquidity. Some critics say a person would probably need to hang onto an annuity for at least a decade or more for the product to become more valuable than many other popular investment vehicles.
�Surrender charges� represent the biggest drawback to annuities and help show why the products do not suit every consumer�s financial situation. These charges result in a percentage-based deduction from the owner�s account if the owner withdraws money or opts out of the contract before a specific date.
The owner�s inability to access money from an annuity can create problems big and small. A relatively small problem concerns the interest rates that are applied to fixed annuities. Imagine, for example, that a person buys a fixed deferred annuity that will credit 5 percent interest to the person�s account annually for seven years and also features a surrender charge that will remain in force for seven years. Three years pass, and industry competition and an improved economy create a financial climate in which many insurers now offer fixed deferred annuities with short-term interest guarantees of 7 percent. The person in our example knows about these better deals but would not be able to get out of the existing contract for another four years without having to pay a significant surrender fee. Now, suppose the circumstances are more serious and that the owner needs money to handle a financial emergency. Even in these urgent cases, the account balance could still suffer a big blow thanks to surrender charges
The federal government and the affiliated financial institution may impose a surrender charge upon people who make withdrawals from their annuities. IRS-mandated surrender charges suggest that the government approves of annuities when they are used for retirement purposes but frowns upon them when they are bought and sold with other motives in mind. Initially, tax laws stipulated that annuity owners would lose 5 percent of their withdrawals to taxes if those withdrawals occurred before the annuitant turned 59 �. The Tax Reform Act of 1986 upped that penalty to 10 percent, where it still stands. This government-imposed penalty tax is separate from the income tax that annuitants must pay when they receive money from the insurance company.
For obvious reasons, this surrender charge might make an annuity an immensely uncomfortable fit for young consumers. In 2003, the National Association of Securities Dealers and the national media reported that a financial institution sold a $30,000 annuity to an 18-year old. Based on current tax law, a person of that age would probably not be able to access the $30,000 to buy a home, purchase an automobile, fund a college education or pay off debt until more than 40 years have passed.
There are some exceptions that can nullify the 10 percent tax penalty. The penalty generally does not apply under the following circumstances:
Even if an annuitant has passed age 59 �, the owner might still need to pay an insurer�s surrender charge when money comes out of an annuity prematurely. Insurance companies tend to lose money on an annuity during its early years, and surrender charges help make up for losses if the owner cancels the contract before the issuing company can make a profit on it.
At first, it may seem improbable that a financial institution would lose money in the early years after a sales transaction, particularly when buyers are often paying six-figure lump sums for immediate and deferred annuities. But, as is the case with a lot of life insurance transactions, the initial premium for an annuity helps pay producers� commissions. An annuity�s high or lengthy surrender charge might be the result of a high commission for the agent or broker. Conversely, low surrender charges might be the result of a low commission for the agent or broker.
Sometimes, a prospective buyer can purchase an annuity directly from the insurance company, thereby avoiding commission costs and probably getting lower surrender charges within the contract. Of course, a direct purchaser might lack the expertise that trained, professional agents or brokers can provide. Consumers must also realize that direct purchases probably won�t eliminate surrender fees altogether because the fees also cover various administrative costs and contribute to an overall pool of money that allows the insurer to satisfy contractual guarantees.
Surrender charges can differ greatly, depending on the type of annuity and market conditions. All surrender charges will have an impact on an annuity�s cash value, but the exact impact will vary among contracts. In some cases, the surrender charge will come out of the annuity�s total cash value. At other times, an insurer might only take surrender fees out of the principal and leave accumulated interest alone. On occasion, principal will remain intact, and the insurer will deduct the interest earned over a set period of time from the owner�s account.
If consumers research annuities via the mainstream media, they will probably come to the conclusion that there is a standard surrender charge for annuities that starts at 7 percent or so and lasts roughly seven years, with each passing year resulting in a 1 percent reduction in the fee. In reality, the size and duration of a surrender charge can be better or worse than that. In terms of length, research conducted during the development of this course uncovered annuities with surrender fees that were as brief as three months and as long as the annuitant�s lifetime. In terms of size, one annuity came with a surrender charge that began at a rate of 25 percent. Another product combined long duration with large size by reportedly featuring a surrender charge that started at nearly 18 percent and lasted 17 years.
People with an interest in flexible-premium annuities ought to be aware of �rolling surrender charges.� A rolling surrender charge is tied to all money invested at a particular time. If, for example, someone buys a flexible-premium annuity with a $10,000 initial investment, the insurer might allow the owner to withdraw the $10,000 without penalty after seven years or so. But, if the owner puts an additional $5,000 into the annuity at a later date, a new surrender charge might apply, and the owner might need to wait an additional seven years or so before he or she can access the $5,000.
State governments (which regulate most insurance matters in this country) can force insurance companies to balance their surrender charges with some consumer-protection measures. In California, for instance, insurers must follow disclosure requirements related to surrender charges, as spelled out in the state�s insurance code. In the following excerpt, the code sets specific disclosure requirements for fixed and variable annuities sold to people who are at least 60 years old. The sampled text makes it clear that insurers must not only disclose surrender charges but also put disclosure language in a reasonably sized font near the beginning of the contract. It also mandates that the insurer inform seniors of the amount of money they would receive from the company if they were to surrender the annuity contract:
10127.12. Whenever an insurer provides an annual statement to a senior citizen policyowner of an individual life insurance policy or an individual annuity contract issued after January 1, 1995, the insurer shall also provide the current accumulation value and the current cash surrender value.
10127.13. All individual life insurance policies and individual annuity contracts for senior citizens that contain a surrender charge period shall either disclose the surrender period and all associated penalties in 12-point bold print on the cover sheet of the policy or disclose the location of the surrender information in bold 12-point print on the cover page of the policy, or printed on a sticker that is affixed to the cover page or to the policy jacket. The notice required by this section may appear on a cover sheet that also contains the disclosure required by subdivision (d) of Section 10127.10.
Insurance companies understand that these fees can cause customers to pause before coming to a long-term financial agreement, and they have responded with some degrees of compromise. In exchange for paying higher annual fees, shoppers might be able to buy rare annuities that lack a surrender charge. Sometimes fixed annuities with long-lasting surrender charges will feature higher introductory interest guarantees because the insurer will likely have more time to invest the premiums and to earn a substantial profit on them. In efforts to hang onto existing customers who might be itching to cancel their annuity contracts once the period for surrender fees expires, some insurers offer bonus interest when annuity owners agree to keep their contracts in force after the penalty period passes. Or, the insurer might simplify the process of moving the owner�s money from the current annuity to a new one with better rates.
Insurance companies recognize the liquidity-related problems consumers have with the annuity and are increasingly offering clients some wiggle room so that invested dollars and cents are at least somewhat accessible during times of want or need. Insurers soften their sometimes rough surrender penalties by usually giving owners a chance to withdraw small amounts of money from their annuities without losing any additional principal or interest gains. Most contracts allow annual withdrawals that may not exceed 10 percent of principal at one time, though some increase the limit for maximum withdrawals to 15 percent, and some annuities allow for no free withdrawals. Free withdrawal provisions can sometimes rival surrender charges in the subtle yet important ways that they differ from contract to contract. Before they prepare to withdraw from an annuity, owners should understand there might be a waiting period (perhaps one year) before the penalty-free withdrawals may begin. Owners should also know that these withdrawals might not be permitted forever. The insurer can limit withdrawals by disallowing them after a pre-determined number of years or by putting an end to them once cumulative withdrawals reach a set percentage of the principal. On the positive side, restraint by the owner might translate into greater opportunities for withdrawal at a later date. Some companies increase the maximum allowable withdrawals each year for clients who have not already taken money out of their annuities.
The free 10 percent withdrawals keep surrender charges at bay for people who need a little extra cash now and then. They do not, however, exempt the owner or annuitant from tax laws. People must still pay income taxes on these partial withdrawals, and the government will still knock payouts down by 10 percent if they occur before the annuitant turns 59 �. Some annuity contracts let owners take out varying amounts of interest without suffering surrender penalties or minimizing their principal, but these withdrawals will also count as taxable income.
Annuity owners can use the money from an annual penalty-free withdrawal for anything they choose. Crisis riders and crisis waivers, on the other hand, can only be used to support the owner or annuitant during specific financial emergencies, such as those involving a disability, a chronic health problem or unemployment. A rider or waiver may entitle someone to more than 10 percent of the principal each year.
While some �crisis waivers� only waive surrender charges for withdrawals below a certain dollar amount, others let the owner make a clean break with the insurer without penalization. A �crisis rider� can do more than just eliminate a surrender charge. These contract add-ons might either increase payouts if the annuitant experiences a crisis after annuitization or may incorporate an insurance policy into the contract. In the latter case, the owner would basically be getting a discount for buying two insurance products at once. Products that bundle annuities together with insurance policies may require more extensive medical underwriting than annuities that merely waive surrender charges.
Considering the annuity�s status as a popular product for older consumers and retirees, it makes sense for long-term care (LTC) waivers and riders to receive more attention than those riders and waivers that cater to the unemployed or to young or middle-aged disabled people. Improvements in life expectancy and the aging of the Baby Boom generation have sparked tremendous growth in LTC health services and in the marketing of financial products that can help individuals and families pay for those services.
The variety of available settings for LTC exemplifies the changes made in the health care and insurance industries during the past 20 years in this regard. Years ago, nursing homes or family residences were the common destinations for older people who needed a little help with daily activities. Since then, that short list of residential options has grown much larger to include assisted-living communities, life centers, adult day-care centers and the LTC patient�s own home.
LTC insurers, as well as annuity producers who offer LTC waivers and riders, have responded to the increase in care options by adjusting their policies and contracts to cover the newest forms of treatment. In the old days, LTC riders provided financial protection against long stays in nursing homes or hospitals, but modern add-ons can also lower the cost of at-home care.
Financial products that contain LTC benefits must be evaluated and purchased with some caution. Consumers risk paying higher than expected medical bills when they fail to understand how LTC insurance benefits are triggered or when those benefits will begin. State governments have adopted minimum benefit triggers and forced LTC insurers to include various other contract provisions within their policies, but the laws associated with LTC insurance policies might not apply to LTC crisis waivers, which merely nullify surrender charges and do not force the issuing company to pay directly for anyone�s care. LTC riders that merely increase payouts to annuitants might not need to meet various statutory requirements either, because they, too, do not force the issuing company to pay directly for health care. Like crisis waivers, they merely put owners and annuitants in a potentially better position to handle LTC expenses.
In order for the owner or annuitant to receive LTC benefits through a waiver, rider or insurance policy, someone must demonstrate a contractually defined need for care. In general, LTC benefits are given to people who live with a cognitive impairment (such as Alzheimer�s disease) or who cannot perform common tasks called �activities of daily living� (ADLs). For LTC benefits to be triggered by an inability to perform ADLs, a person usually must require assistance when doing at least two of the following six tasks:
After demonstrating a need for LTC, the owner or annuitant must wait for an �elimination period� to pass. During the elimination period, the person receives no privileges or benefits through the LTC waiver or rider and will need to pay out of pocket for care unless he or she has adequate health insurance. The length of the elimination period will depend on the contract and might be left up to the owner at the time of purchase. In general, contracts with longer LTC elimination periods will go hand-in-hand with smaller fees or premiums, and short elimination periods will probably mean higher fees or premiums for the owner. Elimination periods for LTC crisis waivers or riders can range anywhere from 30 days to several months.
Eligibility for LTC benefits within an annuity is far from guaranteed, particularly due to the link between people�s age and their susceptibility to long-term health problems. Some insurance companies only offer LTC waivers and other health-related add-ons to owners or annuitants who have not had major health problems, and the opportunity to withdraw funds specifically for health reasons might expire as the owner or annuitant grows older.
Similar crisis waivers include those for disability or terminal illnesses. Triggers for disability benefits may also be tied to one�s ability to perform ADLs, but the owner or annuitant will want to check to be sure. According to National Underwriter, elimination periods for disability waivers can be as brief as 0 days or as long as six months. Terminal illness waivers will usually exempt the annuity owner from surrender charges if the person�s remaining life expectancy has dropped to one year or less. Non-retirees can also take advantage of unemployment waivers, which in many instances eliminate surrender charges if the owner has been out of work for at least six months.
As helpful as crisis waivers and riders can be to some consumers, the improvements they make on an annuity�s liquidity do little, if anything, to solve tax issues or to increase affordability. Money withdrawn due to an LTC, disability or unemployment crisis will still count as taxable income, although a disabled individual can escape the penalty tax on withdrawals made prior to age 59 �. Riders that increase payouts in a crisis or give the owner or annuitant insurance-level protection rarely ever come without a cost. As a result, the benefit rates for these enhanced annuities will be lower than usual, and any applicable fees might also be higher than usual. Admittedly, these riders can benefit the public, particularly when disability or LTC coverage is otherwise unavailable to the owner or annuitant. But some financial advisers say buyers might be better off in the long run if they purchase pure LTC, disability or unemployment insurance policies and allow their annuity to grow in value without any bells and whistles attached to it.
As a contract that is underwritten by an insurance company but often designed for tax-deferred growth of principal, the annuity sometimes occupies a gray area that exists between insurance policies and investment products. From a regulatory standpoint, annuities get the investment treatment, but some producers insist that an annuity�s death benefit helps make the product a form of insurance, too.
Annuity death benefits are not nearly as simple as those found in life insurance policies. The typical annuity offers a death benefit that is at least equal to the principal investment, minus any withdrawals made during the annuitant�s lifetime. If a fixed or variable annuity experiences positive investment gains and is worth more than the principal sum when the annuitant dies, beneficiaries can collect this larger amount instead, although they will need to pay income taxes on the accumulated interest.
At first, this might sound fair or even favorable to beneficiaries, but there is a big catch. The standard death benefit usually applies only if the annuitant dies while the annuity is in the accumulation period. If the person has purchased an immediate annuity or has annuitized a deferred annuity, the insurer will likely pocket the remaining balance in the account and use the money to make payouts to its other clients.
An annuity that only pays a death benefit if the annuitant dies during the accumulation period is sometimes called a �straight life annuity� or a �single life annuity� because the money given to the insurance company is meant to last for the rest of one person�s life and is not invested with dependants in mind. The insurance company bases the size of payouts from this kind of annuity on the annuitant�s remaining life expectancy at annuitization and is not contractually obligated to pay out any money after the annuitant dies, unless annuitization never began. Because straight life annuities provide money to an annuitant or a beneficiary but not to both parties, the insurance company can afford to give straight life annuitants its highest benefit rates.
Straight life is hardly the only settlement option available to annuity owners. People who want to be a little less risky and allow for some death benefits after annuitization can opt for a single life annuity with �period certain.� When the period certain option is added to a single life annuity, the annuitant still receives lifelong payouts from the insurance company, but the period certain helps guard against the annuitant dying suddenly after annuitization and leaving nothing for heirs. The period certain option guarantees that payouts will at least continue for a contractually mandated time period, usually in the neighborhood of 10 or 20 years. If for example, the annuitant starts receiving payouts from a single life annuity with a period certain provision of 10 years and dies after five years, the annuitant�s beneficiary could then step into the annuitant�s place and receive payouts for the remaining five years of the contract. If that same annuitant bought that same contract and received payouts for at least 10 years, the insurance company would not need to pay any money to a beneficiary upon the annuitant�s death. When the period certain ends, so does the beneficiary�s right to any death benefit.
Because life with period certain annuities involve limited guarantees to more than one person after annuitization, the individual payouts will be slightly smaller (perhaps by 5 percent or 10 percent) than those available through straight life contracts. The degree to which benefit rates are reduced, compared to straight life annuities, will depend on the length of the period certain. A short period might not affect payouts or rates much at all, while a long period could translate to a substantial financial sacrifice for the annuitant during his or her lifetime.
A third settlement option can give heirs a death benefit no matter when the annuitant passes away. In this setup, beneficiaries receive a refund of any principal that remains in a deceased annuitant�s account. Beneficiaries receive none of the interest that might have accumulated in the account, and they get nothing if the annuitant lived long enough to receive a full return of principal. The refund of principal can go to beneficiaries in one of two ways. In a �cash refund� annuity, the beneficiary receives the death benefit in a lump sum. An �installment refund� breaks up the death benefit and awards money to the beneficiary periodically until all principal has been paid back.
If buyers want a beneficiary to have access to an income stream on a long-term basis, they can purchase a "joint-survivor annuity", which covers two lives and is popular among spouses. When one annuitant dies, the other annuitant continues to receive payouts from the annuity until his or her death. Sometimes, the payouts made to the survivor will be the same size as those made during the deceased�s lifetime. If a husband and wife receive $800 each month from a joint-survivor annuity, and the husband dies, the wife might still receive $800 each month for the rest of her life. But, in a lot of joint situations, the payouts to the survivor are a fraction of what the couple usually received. The joint annuitants might structure the contract so that the survivor receives one-half or two-thirds of the usual, periodic payout. Because joint-survivor annuities make guarantees that span two lives, the payouts and benefit rates for these products can be significantly lower than those for single life annuities.
Do not confuse joint-survivor annuities with �joint-life annuities,� which pay money to two annuitants but stop payouts after either person�s death.
Some insurance companies have enhanced their annuities� death benefits by pairing them with life insurance riders that cover accidental death. These riders might appeal to consumers because they can significantly enlarge the death benefit if the annuitant dies in an accident and because they are sometimes cheaper than stand-alone life insurance policies. However, like most other riders, their cost can have a detrimental effect on an owner�s account balance. If buyers already have life insurance or can provide for beneficiaries through other means, their need for this coverage might be minimal at best, particularly if the insurer�s asking price is high.
The same might also be said in regard to the importance of any of the other death benefits available through an annuity, but the ultimate choice between buying a plain, straight life annuity and paying more for a contract with greater death benefits will depend on the individual�s financial situation and the person�s private desire to eventually pass wealth along to dependants, loved ones or other parties.
The federal government allows people to exchange insurance policies for annuities and to exchange one annuity contract for another annuity contract via a �1035 exchange�, which is named after the provision�s placement in the tax code. The ability to move money from an old annuity contract to a new one can be beneficial to investors when their current contract is not accumulating much interest compared to other products in the market. Insurance companies sometimes make a potential exchange even more enticing to the consumer by offering special bonus interest to people who agree to move old money into a new annuity. In some cases, these bonus rates will help lessen the sting of any surrender charges that are applied by the old insurer when the transfer is executed.
One potential problem with annuity exchanges is that old money invested in a new annuity will automatically introduce a new time period of several years, during which surrender charges may be in effect all over again. So, money that finally became accessible after many years under the old contract may suddenly lose its liquidity under the new agreement.
Alleged unethical conduct in the exchanging of annuities has caught the eye of regulators in recent years. Some observers believe that the opportunity for decent commissions on annuity transfers has successfully tempted insurance producers and others within the financial services industries to avoid telling consumers about fresh surrender charges. A few financial institutions, including some insurance companies, have conducted self-policing and have even eliminated or restructured commissions for employees who handle annuity transfers and exchanges. In 2006, the National Association of Securities Dealers issued an investor alert, warning consumers that an exchange will not always serve a variable annuity owner�s best interests. According to the alert and NASD rules, insurance agents or brokers can only pursue an exchange if it is in line with a client�s financial status and risk tolerance.
If the annuity purchaser is at all displeased with any aspect of an annuity contract, including the many intricacies we have studied thus far, he or she can exercise rights stipulated in an annuity�s �free-look period,� which grants the owner several days to cancel the annuity and receive a full or partial refund of the principal. In most cases, the refund of principal will be in full. On occasion, a variable annuity contract that invests premiums immediately in mutual funds may only call for a return of the annuity�s value at the time of cancellation. Different states mandate different free-look periods for annuities, with the penalty-free cancellation period lasting anywhere from 10 days to 30 days. In some jurisdictions, senior citizens receive an extended free-look period when they purchase annuities or other financial products.