The material presented on our web site may contain concepts that have
legal, accounting and tax implications. It is not intended to provide
legal, accounting or tax advice, you may wish to consult a competent attorney,
tax advisor, or accountant.
Note: Any reference to the word guarantee is based on the claims paying
ability of the underlying insurance company.
An annuity is a contract issued by an
insurance company. It is a unique financial product that provides tax
deferral of interest and capital gains and the option (if funds are
annuitized) of a guaranteed monthly income for life. Although annuities
can serve various needs, the primary purpose of an annuity is that of
a retirement vehicle for the annuitant, the person who will usually
receive the annuity benefits. The annuity is an attractive retirement
vehicle because the money accumulating in an annuity, grows on a tax
deferred basis. There are two parts to an annuity: the accumulation
phase and the distribution phase.
After accumulating money in an annuity
it is not mandatory that the annuitant exercise the annuitization option
and relinquish control of his or her cash value and enter into the annuity
distribution phase, the annuitant can simply cash out of his or her
The Accumulation Phase
During the accumulation phase, the fund grows tax deferred, it does
not grow tax free. If the annuity was not purchased as part of a qualified
retirement program such as an IRA, 401(k), TSA, or 457 plan, income
taxes are paid on the earnings when money is ultimately paid out.
If the annuity is part of a qualified plan the entire fund is subject
to income taxes as it is withdrawn.
Surrender charges for early withdrawals.
If you withdraw money from your annuity before age 59 ½ it is called
a “premature distribution” and is subject to an additional 10% IRS
If a premature death should occur, the accumulated funds within the
annuity are transferred to the named beneficiary, avoiding probate
Annuities can vary by payment mode and are available as “single
premium” (purchased with one-time payment) or
“flexible premium” (purchased with recurring periodic payments).
They also vary by timing of the annuity income and may be available
as a “deferred annuity” (which means
that annuity income payments are deferred until later) or as an
“immediate annuity” (which means
that annuity income starts immediately).
For fixed and indexed annuities there is safety of principal
- Variable products are subject to mortality and expense charges and
administrative fees not typically found with other investments.
In a fixed annuity, the insurance carrier:
Declares a current rate of interest for a specified time period.
Once the time expires the company will set a new rate which may
be higher or lower than the original rate.
Guarantees a minimum interest rate of return which is specified
in the contract, and at no time may the current or renewal interest
rate fall below it.
Guarantees the principal.
A variable annuity has two types of accounts:
In a fixed account, principal and interest are guaranteed by the
insurance company. Interest rates are usually guaranteed for one year
but can be longer.
In a variable account, the annuity owner bears the investment risk.
Policy values vary directly with market performance and may result
in a loss of principal and prior earnings. Earnings are tied directly
to the performance of various underlying investment vehicles which
are available within the variable annuity and are selected by the
An Indexed Annuity has interest rates that are linked
to growth in the equity market as measured by an index such as the S&P
500. The owner enjoys the upside potential of equities but is not
exposed to downside risk. Subject to fixed minimum guarantees, the value
of an indexed annuity can only increase due to market growth – it will never decline
due to market movement. There are many variations in product design.
No two of the indexed annuities are exactly alike, and some are very different from
each other. However, all the various types fall into three general categories:
annual reset, point-to-point, and annual high-water mark with look-back. The following
is a simple definition of each. Please call us if you would like to know more.
Annual Reset – Also known as the annual
ratchet design, the annual reset design resets the starting index
point annually. It also credits index increases (interest) annually
and compounds annually.
Point-to-Point – The point-to-point
design measures the change in the index from the start of the term
to the end of the term.
Annual High-Water Mark with Look-Back
– The annual high-water mark with look-back can be viewed as a
variation on the point-to-point design, except that it measures the
index from the start of the term to the highest anniversary value
over the term.
* Some annuities allow the insurance company to change participation
rates, cap rates or spead/asset/margin fees either annual or at the start
of the next contract term. If an insurance company subsequently lowers
the participation rate or cap rate or increases the fees, this could adversely
affect an investor's return. Therefore, a prospective investor must carefully
review his or her contract in order to examine these issues.
Withdrawals may be made at any time. However, the withdrawal may
be subject surrender charges and if done before age 59 ½ there will
be a 10% IRS penalty. Some contracts allow an annual 10% withdrawal
free of surrender charges.
The owner may pre-authorize a systematic periodic withdrawal plan.
The owner of the contract instructs the company to withdraw a percentage
or a level dollar amount from the contract on a monthly, quarterly,
semiannual, or annual basis.
The Distribution Phase
As part of the distribution
phase, the owner has two options, he or she can withdraw money (either
in a lump sum or elect a systematic withdrawal plan) or annuitize (purchase
an annuity pay out plan).
Annuity Pay Out Plans
When the owner annuitizes the funds he or she purchases an annuity
pay out plan. In a Fixed and in an Indexed Annuity the owner
purchases a monthly income that will be paid to him or her until death.
It is a guaranteed income that will not change. In a variable annuity,
the owner has an option to do the same or transfer all or part of
the contract to one or more of the sub-accounts that are available,
and annuitize those funds. The funds that are annuitized in the separate
accounts produce an income that will change from month to month based
on the performance of the sub-account that the funds are placed in.
Life Only - Periodic monthly payments
to an annuitant for the duration of his or her lifetime and then ceases.
It is for a lifetime, the annuitant cannot outlive the payments. The
payments are determined at the time of purchase and are based on age
Life with 10 years certain – Payments
will be made for at least ten years, regardless if the annuitant lives
for the entire ten years. If the annuitant dies during the ten-year
period the remainder of the ten-year payments will be made to a beneficiary.
If the annuitant lives longer than ten years he or she will continue
to receive payments for his or her lifetime. The guaranteed monthly
payments will be less than “life only.”
Life with 20 years certain – Payments
will be made for at least twenty years, regardless if the annuitant
lives for the entire twenty years. If the annuitant dies during the
twenty-year period the remainder of the twenty-year payments will be
made to a beneficiary. If the annuitant lives longer than twenty years
he or she will continue to receive payments for his or her lifetime.
The guaranteed monthly payments will be less than “life only”, and “Life
with 10 years certain.”
Wm.Scott Carter Insurance Agency #0703360
1820 W Carson St. Ste 221 | Torrance, CA 90501
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This web site may contain concepts that have legal, accounting and tax implications. It is not intended to provide legal, accounting or tax advice. You may wish to consult a competent attorney, tax advisor, or accountant.