What Different Kinds of Annuity Arrangements are Available?
Single Premium or (Flexible or Scheduled) Installment Premium
(When and How You Pay into the Annuity Fund)
The premium is the money you pay an insurance company to buy an annuity contract. A single premium annuity means you pay the insurance company only one premium.
An installment premium annuity is designed for a series of premiums.
Many installment premium annuities are flexible premium contracts. This means you can pay as much as you wish, whenever you wish, within limits specified in the contract.
Some installment premium annuities are scheduled premium contracts. This means the contract sets out the size and frequency of premiums you must pay. For example, you may pay $100 per month for the entire accumulation period.
The accumulation period (also called the "growth period") is the time between when you start paying premiums and when you start receiving income payments. Many annuities end their growth periods when the person covered by the annuity reaches age 65, since this is when many people choose to retire.
Immediate Annuity or Deferred Annuity (When the Annuity Begins Paying You)
An immediate annuity provides income payments that start shortly after you pay the premium. The accumulation period may be as little as one day.
People who buy immediate annuities may do so because the money they put into an annuity will not be taxed until it is taken out, either through payment of benefits or withdrawal. This can defer tax payments until a time when their overall income is less and their tax rate may be lower. Immediate annuities are also generally purchased by people of retirement age. Immediate annuities are usually purchased with a single, lump-sum payment.
A deferred annuity provides income payments that start later, often many years later.
With a deferred annuity, you pay one or more premiums over the accumulation period. During this time, earnings build up (accumulate) on the premiums you pay. The premiums you pay and the interest earned goes into a fund called an "accumulation fund".
The annuity payments you will receive begin at a future point in time called the "maturity" date. You will receive payments during a time period called the payout period, or annuitization period.
Deferred annuities can be purchased with either a single premium or multiple premiums paid over a number of years.
Variable vs. Fixed Annuity (How Your Money Earns Interest)
Variable Annuity
The earnings of a variable annuity depend on the performance of the investment options you choose (for example, equity, bond, and money market mutual funds). A variable annuity may also offer the option of putting your money into a fixed account with guaranteed minimum interest. In times where investments are generally falling in value, this may offer you a more secure option. Otherwise, variable annuities have no guarantee that you will receive as much (or more) money as you have paid in, or that you will earn any interest on those funds.
The insurance company will give you a "prospectus" which will explain the annuity before you buy it. The company will probably describe the different investment options in the prospectus, but you may also ask for additional information about the investment options. Study the prospectus carefully and be sure to ask the company about anything you don't understand.
Agents who sell Variable Annuities must have both a Massachusetts insurance agent license and be registered as representatives of a broker-dealer licensed by the National Association of Securities Dealers (NASD) and be registered with the Securities and Exchange Commission (SEC) as well. The SEC also reviews and approves the contents of the prospectus you will receive, and is currently involved in an effort to make these prospectuses much more understandable to consumers.
Variable annuities generally do not provide that your contract will have any minimum value, other than a minimum guaranteed death benefit when death occurs during the accumulation period. Although your annuity contract will usually allow you to switch investment options, including the option of switching to a fixed annuity, if the investments that you have chosen do poorly, your annuity could be worth little or nothing.
Fixed Annuity
During the accumulation period, your money earns interest at rates determined by the insurance company.
Almost all fixed annuity contracts will show a minimum guaranteed interest rate. The minimum guaranteed interest rate allowed in Massachusetts is 3%. By guaranteeing a minimum interest rate, the company is promising your interest rate will not be below the guaranteed interest rate.
The interest rate actually used by a company, usually referred to as the current interest rate (or "declared" interest rate), may be higher, but you should not assume that current rates will always be higher than the guaranteed interest rate.
How current interest rates are determined varies from company to company. Among the factors that a company considers are: the specific terms of the annuity contract you buy; the interest rate the company can earn on its investments; and, the expenses associated with administering and servicing the business.
The day you buy an annuity contract can be important, as a company may change the current interest rate for new contracts from one day to the next.
The interest rate you earn in the first year may be higher than the current interest rate. Companies may use this added interest as a bonus to attract new buyers.
For example, you may buy an annuity and the interest you receive in the first year may be 7%. Some companies may intend to pay you 7% in the future, depending on how investments do, whether their costs go up or down, etc. They may pay more, or they may pay less. However, other companies may intend to pay you less in the second and future years. They do not intend to continue to pay what was a first-year bonus.
You should ask to see the current interest rate for annuities that are in their second or higher year. This way you will know if you can expect the interest rate for the first year to be based on the same factors as the company will use in future years
What Charges May Be Subtracted From The Annuity's Value?
Annuities have charges relating to the cost of marketing or administering the annuity. Some charges may be fixed at the start; others may be changed by the company from time to time. While charges may be directly disclosed and subtracted from the annuity value, other companies offer "no-load" annuities where you pay no direct marketing or administration charges.
A typical contract might contain one or more of the following types of charges listed below.
Percentage of Premium Charge: This charge is deducted from each premium paid. The percentage may be reduced after the contract has been in force for a certain number of years or after total premiums paid have reached a certain level.
Percentage of Net Assets Charge: A regular charge, taken sometimes as frequently as daily, is deducted from the current value of your accounts. This type of charge is usually connected with variable annuities.
Contract Fee: This is a flat dollar amount charged either once or annually.
Transaction Fee: This is a charge per premium payment or other transaction. Variable annuity companies usually allow you to shift money from one investment account to another a limited number of times without charging any transaction fees.
What Happens If I Surrender My Annuity?
Most annuity contracts allow you to surrender all or part of your annuity during the accumulation period. Upon surrender, the annuity terminates. The amount of money you will receive when you surrender your annuity is equal to your annuity value less surrender charges.
For example, if your annuity fund is worth $1,000 in the fifth year of the annuity, that is how much it is worth if you leave it with the company. If you decide to cash in the annuity, you will get less money. If the surrender charge were 9%, you would receive $1,000 less 9%, or $910.
The surrender charge may be reduced or eliminated after your annuity has been in force for a number of years.
In some cases, the surrender charge applies to each premium paid for a certain period of time after that premium payment; this is sometimes called rolling surrender or rolling withdrawal charges. For example, assume that you want to withdraw $3,000 from your annuity which you have had for five years, and you have been paying a premium of $1,000 per year. Also assume that the withdrawal charges on your annuity start at 9% and decrease by 1% for each year. In this case, the first $1,000 of your withdrawal would be charged as though it were from the first year's premium. The withdrawal charge on this money would be 5% ($50), since the premium payment was "five years old". The second $1,000 is "four years old", so the withdrawal charge is 6%, or $60. The third $1,000 is "three years old", and so the interest charged is 7%, or $70. In total, you will be paying $180 of rolling surrender charges.
Because the value of a variable annuity depends on financial markets which tend to fluctuate, if you surrender your annuity at a time when the value is low, you may not get even the equivalent of the contributions you have made.
Even in fixed annuities, some annuities have a "market value adjustment" provision. If you surrender this kind of annuity when the market values of the investments backing the annuity are lower than when you bought it, the company will have to sell the investments at a lower price. This would cause your surrender value to be lower. If the investments are doing well, the surrender value might be higher.
In addition to surrender charges, if you cash in your annuity early you might be hurt in another way.
Although some companies may give a higher than normal interest rate in the first year you buy an annuity, other companies pay higher interest rates in the later years of annuities. In those companies, an annuity which has been in force for more years is earning interest at a higher rate than a newer annuity.
So, if you cash in your policy before the expected year, you may find that you have not earned as much interest as you thought you would. If you had kept the annuity, it would have been earning at a higher interest rate later.
These are called lapse-supported annuities. The people who hold on to their annuities to the end of the expected time earn more money because those whose annuities have been surrendered ("lapsed"), have earned less.
Ask the company if the annuity they wish to sell you is "lapse-supported". If it is, you can expect to lose more money if you cash the policy in early.
Is There Always a Charge When You Take Money out Early?
Some insurance companies do not charge a surrender charge, but most do.
Your annuity may have a limited "free withdrawal" provision. This means you can make withdrawals without charge, of amounts up to a specified percentage of your annuity's guaranteed or accumulated value. Withdrawals above those amounts are subject to withdrawal charges.
Some annuities may waive withdrawal charges in certain situations, for example, if you are confined to a nursing home or are terminally ill.
Some insurance companies allow you to withdraw all of your money without surrender charges if the interest rate they are paying drops below a specified rate. This is called a " bailout provision ".
You should always check for tax consequences on any withdrawal.
Tax payments, or in some cases, tax penalties added to the tax payments required, can make a big difference in the amount of money you receive when you surrender your annuity.
How Much Will an Annuity Cost?
Different insurance companies offer fixed annuities at different costs. There are some common factors which determine how much an annuity will cost you. These include:
- the amount of the annuity you wish to buy
- your age and gender
- the payment option you have selected
- any payment guarantees that are in your annuity.
Variable annuities generally allow you great flexibility in how much money you choose to invest in your annuity. However, there may be minimum or maximum amounts you can contribute. The value of your annuity will be determined by how much you choose to invest and the performance of the investments you choose.
The costs of both fixed and variable annuities are also affected by the insurance company's administrative fees and expenses, including overhead, agent commissions and other costs of doing business.
How Are Benefits Determined?
Annuity benefits are based on two major factors:
- the accumulated value of your annuity is the actual amount in your annuity account when the payout period starts;
- the benefit rate (also called a payout factor ) the insurance company will pay per $1,000 of accumulated value at the time the benefits begin.
The benefit rate may be different for each person who has an annuity, because the rate is affected by your age and sex when the payments begin; the payment option you have selected; and, any guarantees in your annuity.
For example, suppose that at your age, and for the payout option you want, the benefit rate is $6.00. That means that for every $1,000 of annuity fund the company will pay you $6.00 a month for the period specified. If you have $109,300 in the annuity fund, that equals 109.3 thousands. Your annuity income would be $655.80 per month (109.3 x $6.00 = $655.80.)
Annuity contracts contain a table of guaranteed benefit rates, for example, a minimum guaranteed benefit rate of $3.00 per $1,000 in your accumulation fund. Most companies periodically develop "current" benefit rates as well; these rates can be changed by the company at any time, but can never be less than guaranteed benefit rates.
When you are buying an annuity, you may be shown two different values for the annuity. This is called a two-tier annuity.
These annuities contain two payout possibilities. The higher level of payment is available only if the payments are made over a required minimum number of years, or longer. The lower level of payment is used when the funds are paid out in one lump sum, or over fewer years than the minimum required. This lower level of payment may also be found in cases where the annuity provides for multiple benefits, such as payments for long-term care.
Companies usually advertise two-tier policies based upon the higher fund value. Make sure you know the conditions necessary to receive each fund value.
How Are Annuity Benefits Paid Out?
Before the time you begin receiving benefits from your annuity, you will be required to choose the benefit option the company will use to compute and make your payments. Some benefit options (also called "income options") that companies generally offer are listed below. You can usually change the benefit option you have chosen up to the date you begin receiving benefits; but you will not be able to change your choice once benefits are being paid out.
Annuity payments are generally made on a monthly basis, although other options may be available. In some annuities, you may choose whether the payments will be the same amount or whether they will vary.
An option may be for payments to be fixed for a period of time and then to change to another fixed amount. This is often done to match with other payments like Social Security, so that the total payment each period is level.
Another option is for payments to vary as a pre-determined outside index varies. These are called variable payout options. You should check with your company to find out all available options.
How Long Are Annuity Payments Made?
Here are the common income options:
Life Only: You can choose to receive an income for as long as you live. But, there are no payments to anyone after you die.
This type of annuity provides the most income per dollar of accumulation. You might choose this if you want the most income possible, and either have no dependents, or have taken care of them through other means.
Life Annuity with Period Certain: You can choose to receive an income for as long as you live. If you die within a certain period after you start getting paid, usually 10 to 20 years, your beneficiary gets regular payments for the remainder of that period. However, if you live beyond this time frame, payments will continue until your death.
Because the "period certain" provides an added benefit, the amount of each income payment per dollar of accumulation, is less than under a Life Only option.
Joint and Survivor: You can choose income payments for as long as either you or your beneficiary is still alive. When one dies, the amount of the payments may drop by one-third or one-half, according to the contract.
Again, because the "survivor" feature provides an added benefit, the amount of each income payment, per benefit dollar of accumulation, is less than under a Life Only option.
("Joint and contingent annuitant" is a term often used with individual retirement plans like IRA, SEP, and Keough plans. This provision works differently from a "Joint and survivor" provision in an annuity plan. Make sure you understand the specific benefits of the annuity's "Joint and survivor" option before making your decision.)
Installment Refund: Payments are made until your death, but will continue to be paid to your beneficiary for at least as long as is required to pay an amount equal to the amount of money in your accumulation fund.
Is There A Death Benefit?
Annuities may provide that if you die before the income payments start, the annuity value will be paid to your beneficiary. Some annuities provide that the death benefit will be the total premiums paid, if that amount is greater than the value of the annuity at death. Some variable annuities provide what is called an "enhanced death benefit". That means that your death benefit will be set at the highest value your variable annuity account reaches during the time that you have the annuity. Some annuities do not have a death benefit.
Does my Annuity Have Other Benefits as Well as Income and a Death Benefit?
In addition to a retirement income, an annuity may have other benefits, such as an option to use the funds for nursing home costs. An annuity with additional benefits may qualify as a "two-tier" annuity.
Contact for Buying Life Insurance and Annuities in Massachusetts - Part Three
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