Types of Annuities

There is a vast selection of annuities offered in the marketplace today. Because there are so many variations available, consumers are often confused by them. It is sometimes helpful to focus on the following key decision points:

When do you need the income? Immediate vs. Deferred Annuities.

Your first decision point when considering an annuity is whether you want to receive income now or later. The answer to this question will determine whether an immediate or deferred annuity is more suitable for you.

Immediate annuities begin to make payments to you soon after your initial investment. This might be an appropriate option if you are approaching retirement. You can choose to receive your payments for a set period of time like five, ten or twenty years. Another option is to receive income for as long as you live. If you are married, you can choose to have your spouse receive the payments after you die, and those payments would continue for the remainder of your spouse’s life.

With a deferred annuity, you make your purchase payment (or payments) and the insurance company invests your money time until the time you would like to start receiving income. A deferred annuity might be appropriate if you are in your 40’s and want to wait until retirement before receiving payments.

What investment options do you seek? Fixed vs. Variable Annuities.

Within the two main categories or annuities, immediate or deferred, you can either get a fixed or variable rate of return. The decision point in choosing between a fixed or variable annuity is dependent upon whether you want the payout to be an amount certain, in which case you would want a fixed annuity. The other option is to have your income payments tied to the performance of an underlying investment portfolio of your choosing. Deferred annuities base your return on the performance of the underlying funds that the issuing insurance company invested in on your behalf. The insurance company makes a number of sub-accounts available, and you determine how your funds are to be allocated amongst those investment choices.

Fixed annuities offer a guaranteed rate of return. The guarantee typically spans from one to fifteen years. Fixed annuities are secure; you can plan on exactly how much income you will receive. Fixed annuities are usually held in the insurance company’s general investment account and invested in government securities and high-grade corporate bond funds.

With variable annuities, your money is invested by the insurance company in portfolios that are similar to mutual funds. The amount of income you receive fluctuates with each payment depending on the performance of the portfolios you choose.

The insurance company provides you with a wide range of investment options ranging from the full spectrum of asset classes. Many advisors would suggest that you diversify your annuity portfolio much like you do your overall investment portfolio. Therefore, you would invest a portion of your annuity holding in conservative accounts, such as a guaranteed fixed accounts and government bond funds, while also attributing portions to more aggressive investments.

If you are interested in pursuing a variable annuity, one of the key decision points for you will be the breadth of investment choices offered by your insurer.

Variable annuities are considered securities. You should receive and thoroughly review a prospectus for each of the underlying funds before you make an annuity purchase.

Choosing the Right Type of Annuity

Annuities have been around for hundreds of years. Throughout their evolution, annuity issuers have been extremely innovative in the design of the annuity contracts. They have developed multiple features and options to meet even the most unique investor’s goals and objectives. Finding an annuity that is right for you requires you some pre-work on your part. You need to know what you want the annuity to accomplish. You have to figure out whether the stability of a fixed product is right for you, or whether you want the flexibility of choosing the underlying investments. You also have to determine when and for how long you want to receive income.

An annuity purchase should be made carefully and with the input of a financial advisor or insurance agent because, in many cases, the decision is irreversible.
Here are a few important issues to consider when making an annuity purchase:

When will you need the income the most? This will help you determine whether to consider immediate or deferred annuities. Immediate annuities typically begin paying income within 30 days of purchase. Deferred annuities allow you to make your purchase payment in a lump sum, or over a period of time, while the funds accumulate. Your payments will typically commence at a specified date in the future. The longer your investment has to grow, the greater your payments.

How do you want your money invested? Are you looking for a fixed rate of return, or are you willing to accept some level of risk for a variable rate? Personal risk tolerance plays a considerable role in deciding between fixed and variable annuities. If you are risk-adverse and want a guaranteed rate of return, than a fixed rate annuity might be right for you. Other, more aggressive investors are sometimes underwhelmed with the guaranteed rate of return. They think they might be able to do better if they were able to choose the investments themselves. Those people might find variable annuities more tempting because they offer the opportunity to get higher returns than fixed rate annuities.
How long do you want to receive payments? Are you concerned about outliving your means? If so, you might want to look at a lifetime annuity. Alternatively, if you are left without income for only a short period of time (say ten years) before other retirement income commences, a fixed annuity might be right for you.
If you have a spouse or partner that you want to include in your retirement plan, a joint with the right of survivorship annuity may be an appropriate option for you.
What is the issuing insurer offering for guaranteed minimum interest rates?
Do you have access to the money in your annuity in the event of an emergency? What are the liquidation clauses in the contract? Does the insurer have any surrender periods or surrender penalties? These are important considerations particularly if you think you might need access to your money.
What is the fee structure? How is your agent compensated? What additional expenses are associated with the features and benefits? For example, you may be able to get inflation protection for your annuity, but it will come at a cost.
What happens to your annuity when you die? Do you want your annuity assets passed on to heirs? If so, you may have to purchase a death benefit rider.
Are you getting a competitive rate? Your financial advisor can help you shop around for the best rates. There are also tools available on the Internet that makes it easy to do rate comparisons.
What are the tax consequences of your annuity?
How financially strong is the issuing insurer? The promise to provide you with a future income stream is only as reliable as the solvency of the insurance company. You should research the strength and stability of the company and determine its rating with the leading independent rating services. Insurers with high ratings are more financially secure than those with lower ratings.

Annuities are a valuable investment tool that can give you tremendous peace of mind during retirement. Choosing an annuity that does not match your individualized needs could cost you more money in the end. Consider your own unique requirements, age and health, and consult a financial advisor before buying an annuity.

Single, Fixed and Flexible Premium Annuities

Another area of flexibility in annuities is the way in which purchase payments are made. Most insurers offer both single and fixed premiums. Both kinds of annuities have their advantages and disadvantages.

Single Premium Annuities

Single premium annuities are purchased with a single deposit amount. No further payments are expected or permitted.

Often, single premium annuities are funded by money received from an employment arrangement. For example, someone could receive a lump sum of money as part of an employee severance package. Similarly, it is not uncommon for individuals to receive distributions from an employer’s pension or profit sharing plan and use that money to fund an annuity. In other case, single premium annuity premiums come from a lump sum of money from a structured settlement for injury, divorce or an inheritance.

Single premium payments may be made for either immediate or deferred annuities. The income you receive can be for a specified amount at regularly scheduled intervals (making for a single premium immediate fixed annuity), or it may fluctuate based on the performance of the underlying investment sub-accounts you chose (making for a single premium immediate variable annuity).

Fixed Premium Annuities

Single, Fixed and Flexible Premium Annuities

In addition to the single premium method, annuities can be funded with fixed or level premium payments. Under this approach, you pay a regular premium at fixed intervals: monthly, quarterly, semi-annually or annually. Normally you must pay the fixed amount.

Fixed level premiums are akin to a forced savings approach. This method characterizes traditional retirement annuities where the goal is to have a structured savings plan that prompts you to set a certain amount of money aside that will pay reliable income at retirement. Since the advent of more flexible premium payment schedules, this method is no longer as popular as it once was.

Flexible Premium

The most popular method of funding an annuity is through flexible premiums. With flexible premium annuities, the insurance company sends you regular premium notices on the chosen frequency (monthly, quarterly, semi-annually or annually). You can pay the premium billed, an amount above or below the billed premium, or make no premium payment at all. Most insurance companies, however, will impose certain minimum and maximum premium amounts.

Many prefer a flexible premium schedule over fixed because it allows for discretion in premium payments.

History of Annuities

Annuities are among the oldest financial instruments on the market today. They have changed tremendously over time with the evolution of various features and benefits, but the core value proposition of the annuity has been around for hundreds of years.

Annuities can be traced back to the early Roman times when people would make a single payment in exchange for annual lifetime payments. In fact, the term annuity comes from the Latin word “annua” which can loosely be translated to mean annual stipend.

The Roman Domitius Ulpianus developed actuarial life expectancy tables to ensure that profit could be made from the sale of annuities. Initially, he had only limited data to develop the tables, but his calculations proved effectively to predict how long people would live and the risk they presented to the annuity issuer. These actuarial tables, now called mortality tables, remained in use for hundreds of years.

One interesting form of an annuity, called the “tontine,” was used in the 1800’s. It combined elements of a war tax, a lifetime payment plan, and also had a chance-factor. The tontine was a number of annuities all pooled together. Individuals would purchase shares of the tontine in return for income for life. But, here is what makes it so noteworthy. As more participants of the tontine died, the annuity payments to surviving participants increased substantially. The lone surviving participant received a lottery-like payout.

Because survivors benefited from the death of other tontine members, it was deemed to be a motive to murder. By the 1900’s, tontines were no longer sold.

Annuities continued to be used throughout the ages in Europe as a way to raise money and fund wars. Governments found that annuities were attractive alternatives to taxes and bond offerings.

Pennsylvanian Presbyterian minister groups first used annuities in America in 1759. They purchased lifetime annuity contracts to help their aging and retired ministers and their families.

Benjamin Franklin also used annuities to help Philadelphia and Boston provide funds to citizens. The final remaining annuity of this nature was cashed in by the City of Boston in 1991.

Although Ben Franklin was a proponent of annuities, they were slow to rise in popularity in the United States. Only 1.5 percent of the total life insurance premiums collected in the U.S. between 1866 and 1920 went to annuities.

In 1912, the annuity market opened to individuals. Previously, only groups (such as the Presbyterian ministers previously mentioned) could purchase annuities. Individually owned annuities gained in popularity during the Great Depression. People viewed annuities as a much safer alternative to the stock market. Still stinging from the fall of countless banks, Americans were drawn to the financial security and strength of the insurance companies offering annuities.

Legislation enabling the general availability of annuities was passed shortly after Social Security was enacted in the 1930’s. The original intent of social security was to supplemental income. It was not intended to be the primary source of retirement funds. Individuals were encouraged to save for retirement with other investment vehicles, and they were offered tax advantages (such as tax deferral) for doing so.

In 1952, the Teachers Insurance and Annuities Association • College Retirement Equity Fund (TIAA- CREF) came out with an annuity that would base its payout upon the performance of separate investment accounts. This was the first variable annuity to hit the market. The other major insurance companies joined suit, and by the 1960’s were also offering variable annuities. The investment options in these early variable annuities were limited.

In the 1970’s and 1980’s, the government increased regulation of variable annuities causing them to become more uniform.

In 1982, the Tax Equity and Fiscal Responsibility Act (TEFRA) made the modern variable annuity possible. In 1988, the Tax and Miscellaneous Revenue Act (TAMRA) was enacted to tighten loopholes created by an early Tax Reform Act of 1986.

Annuities continue to undergo regulatory scrutiny to curb any abuses.
As a result of the regulatory guidance, insurers now offer a great deal of investment choice, payment options, inflation protection, death benefits and reduced surrender charges in their annuity products.

Annuity Regulation

There are a vast amount of annuities available in the market, but all fit into two broad categories: fixed and variable. The type of annuity you are dealing with dictates how it is regulated.

Here is why: fixed annuities are considered insurance products and regulated as such. Variable annuities are considered securities issued by insurance companies, and therefore regulated by both the Securities and Exchange Commission and the individual state insurance departments.

Fixed annuities offer a guaranteed rate of return. The guarantee typically extends over a period of one to fifteen years. Fixed annuities are secure; you can plan on exactly how much income you will receive. The issuing insurance company typically invests fixed annuity funds in government securities and high-grade corporate bonds. Fixed annuity funds are part of an insurance company’s general investment account. For this reason, fixed annuities are considered insurance products. All fifty states have insurance departments responsible for the regulation of insurance companies and the products they sell. The state regulator’s primary responsibility is to protect the interest of insurance consumers. There is a great deal of variation in the insurance contract requirements from state-to- state. You should buy an annuity only from an agent who is licensed in your state.

There is no federal regulatory body for insurance. There is a nationwide association of state insurance regulators, called National Association of Insurance Commissioners (NAIC). The NAIC provides a forum for the development of uniform policy when uniformity is appropriate.

Variable annuities present more risk than fixed annuities, but offer you the opportunity to enjoy better investment returns. With a variable annuity, you can choose to have your annuity invested in a selection of investment portfolios, called sub-accounts. These sub-accounts are tied to market performance. For this reason, variable annuities are considered securities. As with all other security, variable annuities are regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

Unlike banks that are backed by the FDIC, securities do not offer investors a built-in safety net. The mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The SEC monitors security exchanges, brokers and dealers, advisors, and mutual funds to protect investors against fraud.

A primary goal of the SEC is to ensure that you have adequate and accurate information about your annuity prior to purchase. Therefore, they require the disclosure of certain product information, and mandate that you have been provided with all of the relevant product specifications in the form of a prospectus.

FINRA is an independent self-regulatory group that regulates the securities industry. Its mission is to protect investors by making sure the securities industry operates fairly and honestly. FINRA oversees nearly 4,650 brokerage firms, and approximately 636,500 registered securities representatives.

FINRA touches all aspect of the securities business, from registering and educating industry participants to examining securities firms, writing rules; enforcing those rules and the federal securities laws, informing and educating the investing public, providing trade reporting and other industry utilities, and administering the largest dispute resolution forum for investors and registered firms.

The person selling you a variable annuity must have his or her FINRA Series 6 or Series 7 licenses. In addition, they must be licensed to sell annuities in your state. As part of the regulatory process, your agent must determine whether the annuity product you are contemplating is suitable to you.

Because fixed annuities are not considered securities, they do not require Series 6 or Series 7 licenses to sell. They do, however, require state insurance licenses.

History of Annuities

Because survivors benefited from the death of other tontine members, it was deemed to be a motive to murder. By the 1900’s, tontines were no longer sold.

Annuities continued to be used throughout the ages in Europe as a way to raise money and fund wars. Governments found that annuities were attractive alternatives to taxes and bond offerings.

Pennsylvanian Presbyterian minister groups first used annuities in America in 1759. They purchased lifetime annuity contracts to help their aging and retired ministers and their families.

Benjamin Franklin also used annuities to help Philadelphia and Boston provide funds to citizens. The final remaining annuity of this nature was cashed in by the City of Boston in 1991.

In 1952, the Teachers Insurance and Annuities Association - College Retirement Equity Fund (TIAA- CREF) came out with an annuity that would base its payout upon the performance of separate investment accounts. This was the first variable annuity to hit the market. The other major insurance companies joined suit, and by the 1960’s were also offering variable annuities. The investment options in these early variable annuities were limited.

In the 1970’s and 1980’s, the government increased regulation of variable annuities causing them to become more uniform.