Fixed and Deferred Annuity Learning Guide

Adapted from the NAIC

A fixed/deferred annuity can be either a Single Premium annuity or a Multiple Premium annuity (also known as a flexible or schedule premium annuity).

When you purchase a fixed deferred annuity, you would pay the insurance company only one payment if it is a single premium annuity. You make a series of payments for a multiple premium or flexible premium annuity. There are two kinds of multiple premium annuities. One kind is a flexible premium annuity 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. They vary slightly, so discuss this feature with an agent.

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 (it’s important to review the terms of your contract). These rates are often dictated by the prevailing interest rate environment. Unlike a variable annuity, the insurance company guarantees that it will pay no less than a minimum rate of interest. The guarantees of the company are only as good as the claims paying ability of the company itself.

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 issuing insurance company. When the contract is issued, they may likely have a specified term for which the rate will be guaranteed.

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, which could be one year, or a specific number of years.

·         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. Often times, an insurance company may give you a bonus on an initial deposit, which would cause the first year rate to be higher than subsequent years.

·         The renewal rate is the rate credited by the company after the end of the initial rate time period. The contract tells how the company will set the renewal rate.

Minimum Guaranteed Rate

The minimum guaranteed interest rate is the lowest rate your annuity will earn. This rate will be stated in the contract. This is important for you to review and understand when entering into 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 (in the case of flexible premium annuities). Other annuity contracts may have two or more accumulated values that fund different benefit options, such as income riders, etc. These accumulated values may use different interest rates, and it is important to carefully review these. You get only one of the accumulated values depending on which benefit you choose.

What are some examples of charges a deferred annuity might have?

Most annuities have charges related to the costs of selling or servicing it. These charges may be subtracted directly from the contract value, or may be imposed when you make a withdrawal. Ask your agent or the company to describe the charges that apply to your annuity, and be sure that you understand them. 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. Not all annuities have a contract fee. Be sure to ask your advisor to see if this exists in your contract.

Transaction Fee

A transaction fee is a charge per premium payment or other transaction. Again, not all annuities have this fee. Inquire with your agent on this.

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. Again, this is less common, but may still apply.

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 examples of fixed deferred annuity 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.

 

Will my annuity’s value differ depending upon the benefits I choose?

 

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.

 

TELL ME ABOUT THE TAX TREATMENT OF ANNUITIES

 

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 EXACTLY 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.

Questions to 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?

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?