Annuity Basics 101
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Products and riders are available in most states. Availability of
some product features may vary by state. Please consult your
attorney or accountant for legal and tax advice. All value and
numerical demonstrations are for illustration only. Actual results
may vary.
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
An annuity is a contract between an insurance company and the individual
purchasing the annuity (the owner). In return for a sum of money (the
premium), the insurance company makes guarantees to the purchaser.
◦ a guaranteed minimum interest rate for a guaranteed period of time,
◦ a lifetime guarantee that the owner will never receive less than a
minimum interest rate while the money is with the insurance company
(regardless of how low interest rates go)
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
You start an annuity by sending money (called the “premium”) to the
insurance company
◦
Depending upon the annuity’s provisions, the owner may have the ability to pay
additional premiums into the contract value

The premium goes into the annuity’s contract value (or accumulated value)

The account value has a way that it can grow
◦
◦
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Fixed and fixed indexed annuities credit interest to the account value similar to a
bank savings account or certificate of deposit
Variable annuities may credit interest and/or have unit values that can increase
or decrease the value of the account similar to a mutual fund
Guarantees provided by annuities are subject to the financial strength of the issuing insurance company; not
guaranteed by any bank or the FDIC.
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
The owner has the ability to take withdrawals (called “partial withdrawals” or
“partial surrenders”) from the contract value
◦
Doing so may possibly incur a back-end sales charge, called a “withdrawal
charge”

The owner also has the ability to terminate the contract and receive the
accumulated value, less any surrender charge

If the owner dies, the owner’s beneficiary receives the “death benefit,”
which is usually equal to the contract value
◦
◦
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The beneficiary has no rights under the contract, other than to receive the death
benefit
Most carriers do not assess a withdrawal charge on the death benefit
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 Tax deferred growth
 Safety of principal and earnings
 Guaranteed minimum interest rate
 Long-term accumulation vehicle
 May avoid probate with current beneficiary designation
 Protected from creditors (varies by state)
 Liquidity options
 Flexible income payouts
 No limits on contributions (non-qualified annuities)
There is no additional tax deferral benefit for contracts purchased in an IRA or a tax-qualified plan, since these are already afforded taxdeferred status. Therefore, an annuity should only be purchased if the client values some of the other features of the annuity. Guarantees
provided by annuities are subject to the financial strength of the issuing insurance company; not guaranteed by any bank or the FDIC.
Annuities contain limitations including withdrawal charges, fees and a market value adjustment which may affect contract values.
Guaranteed principal assumes no withdrawals in excess of the free amount.
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Ways that Your Annuity Value
Can Grow
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
There are three different types of annuities

They differ primarily in how your contract value has the opportunity to
grow
◦ Fixed annuity: credits a fixed interest rate declared by the insurance company
◦ Fixed Indexed annuity: credits interest based on a portion of upward movement of
a stock market index
◦ Variable annuity: is invested in stock, bond, or other sub-accounts that can
increase or decrease in value daily based on the market performance and
underlying funds

All three types offer tax deferral of growth
Tax-deferral offers no additional value if an annuity is used to fund an IRA; purchase an annuity for reasons other than tax-deferral benefits
beyond those inherently provided by an IRA, such as lifetime income and a death benefit.
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
Fixed Annuity
◦ Contractually guarantees that your principal is protected from loss, subject only to
a surrender charge, which is an avoidable charge
◦ Credits a fixed interest rate that is declared in advance by the company and is
typically guaranteed not to change for one or more years at a time
 After that initial guarantee period, the interest rate is subject to change by
the carrier and is typically set at the carrier’s sole discretion
◦ Has a liquidity restriction in the form of a withdrawal charge which is assessed
against large withdrawals or total cancellation in the early years of the contract
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
Fixed Indexed Annuity
◦ Just like a traditional fixed annuity, contractually guarantees that your principal is
protected from loss, subject only to a surrender charge, which is an avoidable
charge
◦ Declares at the beginning of each policy year a formula, based on a stock market
index, that will be used to calculate the interest credit that will occur at the end of
the policy year
 At the beginning of each subsequent policy year, at least one element of the
formula is subject to change by the carrier and is typically set at carrier’s
sole discretion
◦ The appeal of an fixed indexed annuity is that you have growth potential, along
with protection from loss
◦ Fixed Indexed annuities are a type of fixed annuity, therefore they are not
registered as securities and may be sold by licensed life/annuity agents
Fixed Indexed annuities are not registered securities or stock market investments and do not directly participate in any stock or equity investments.
Market Indices do not include dividends paid on the underlying stocks, and therefore do not reflect the total return of the underlying stocks; neither an
Index nor any market-indexed annuity is comparable to a direct investment in the equity markets. Clients who purchase Fixed Indexed annuities are
not directly investing in a stock market index.
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
Variable Annuity
◦ Allows the owner to choose from a variety of mutual fund-like sub-accounts, such
as bond and stock accounts, which can increase or decrease in value daily, along
with a menu of standard and optional benefits that can provide important and
valuable protections against loss
◦ Can provide a hedge against inflation and an increased opportunity for growth, but
there is also a risk the investment performance will be poor and the annuity’s
value will be reduced or lost
◦ Variable annuities are securities, thus to sell them you must hold a valid FINRA
Series 6 and state license series 63 where required
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1.
2.
3.
What is your tax rate?
What rate would you like to earn?
How much can you invest?
28%
6%
$100,000
This hypothetical example is for illustration purposes only and is not indicative of past, nor intended to predict future performance of any Index
or annuity. This example includes the optional restart of the Accumulation Period at the end of the 10th Contract Year. The Income Account
Value may not quadruple if you do not elect the restart. The owner is responsible for electing the restart.
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$265,330
$162,889
$142,429
$207,293
$169,979
$202,859
The illustration assumes a $100,000 payment, a
5.0% interest rate, and a 28% tax bracket. It is
important to remember that money distributed
from an annuity will be subject to taxation at
that time.
This hypothetical example is for illustration purposes only and is not indicative of past, nor intended to predict future performance of any Index or
annuity product. Tax-deferral offers no additional value if an annuity is used to fund an IRA; purchase an annuity for reasons other than taxdeferral benefits beyond those inherently provided by an IRA, such as lifetime income and a death benefit.
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Benefits of Owning an Annuity
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 The following provisions might not be available on all contracts and there
might be an extra charge:
 Withdrawal Privileges
 Guarantee Return of Premium
 Disability Waiver
 Terminal Illness Waiver
 Nursing Home Waiver
 Lifetime Income Options
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Waiver availability varies by State; additional limitations may apply.
Guarantees provided by annuities are subject to the financial
strength of the issuing insurance company; not guaranteed by any
bank or the FDIC.
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Comparison of Benefits
Benefits
Fixed or Index
Annuity
Contractual Protection
from Loss of Value
Money Market
X
Ability to Add Money
at Any Time
Tax Deferral
X
No Fees Required
To Purchase
Legend:
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=Benefit Included
CD
X
X
Corporate
Bond
X
X
X
X
X=Benefit Not Included
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Details on Annuity Taxation
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice. Please consult with a professional specializing in these areas regarding the applicability of
this information to your situation.
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Non-qualified Plans
Qualified Plans
An annuity purchased by an
individual to meet retirement
income needs. Non-qualified
contributions are made with aftertax funds, interest accumulations
grow tax-deferred until withdrawn.
The policyholder has already paid
income taxes on the money that is
placed into this policy. When the
money is taken out, taxes are
paid on the “gain.”
A retirement plan offered by an
employer and established under the
federal income tax code which
permit the exclusion of plan
contributions from current income
tax (pre-tax funds). Interest
accumulates tax-deferred until it’s
withdrawn. Examples: 401K and
403b
Tax-Advantaged Annuities
Offer similar tax benefits as
employer-sponsored qualified plans,
but they set up and owned by an
individual. Examples: IRAs & SEPs
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice.
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Section 1035
Tax-Free Exchange
◦
Tax-free exchange of a
non-qualified annuity to a
new non-qualified annuity,
usually through a direct
transfer between insurance
companies. Also refers to
such an exchange of a life
insurance policy for a nonqualified annuity. For the
exchange to be tax-free,
ownership of the new
policy must be identical to
the old policy being
exchanged, and the
exchange is limited to cash
value/surrender value of
the old policy.
Rollover
◦
A tax-free transfer of
funds, usually by the owner
of an IRA, SEP, or 401k,
transferring funds to a new
IRA, SEP or 401k or from a
qualified plan to make an
IRA or SEP. With a rollover,
the owner receives the
funds from the current plan
and makes the transfer to a
new plan. To be tax-free, a
rollover must be completed
within 60 days from the
time the owner takes
possession of the funds.
Transfer
◦
A tax-free transfer of
funds, usually by the
current company to the
new company. In order to
be tax-free the ownership
must be identical from the
old plan to the new plan.
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice.
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1. The original investment, paid for with after-tax dollars represents the cost basis
in the annuity and will be returned tax free.
2. The untaxed earnings on the principal will be subject to tax.
Non Taxable
Portion
Cost Basis
Taxable
Portion
Tax Authority
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice.
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Accumulation
Annuities
Taxation
•Interest is taxdeferred
•No tax until
withdrawal
•Principal is
never taxed (nonqualified)
•10% Federal
penalty may
apply on
withdrawals prior
to age
59 ½
•1035 tax-free
exchanges
Most annuities allow you to take unscheduled partial or full
withdrawals from your annuity contract. If you make such a
withdrawal, for tax reporting purposes, you are deemed to be
withdrawing any untaxed interest or growth first, and any untaxed
amounts must be exhausted before you are deemed be withdrawing
non-taxable cost basis.
Annuities also optionally allow you to receive the proceeds of your
annuity as a series of scheduled periodic payments over a period of
years. The rules in section 72 of the Internal Revenue Code govern
the income taxation of such payments. In general, section 72
permits you to recover your non-taxable cost basis in the contract on
a pro rata basis over your life expectancy. To achieve this, each
annuity payment is divided into two parts:
1. The nontaxable portion that represents the return of premiums
paid into the annuity (cost basis).
2. The taxable portion that represents the interest earnings that
were not taxed previously during the accumulation period.
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice.
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
In order to discourage the use of annuity contracts as
short-term tax sheltered investments, a 10% tax is
imposed on certain “premature” payments under
both qualified and non-qualified annuity contracts.
On qualified annuities, the penalty is on the entire
amount. On non-qualified annuities, the penalty is
on the gain of the contract. The 10% excise penalty
does not apply to any of the following distributions:
1) Distributions made on or after the date on which
the taxpayer becomes age 59 ½.
2) Distributions after the owner’s death.
3) Distributions over the life expectancy of the
participant or the joint life expectancy of the
policyholder and their primary beneficiary.
4) Distributions due to the policyholder becoming
disabled.
5) Distributions made from an annuity purchased by
an employer upon the termination of a qualified
plan and held by the employer until the
employee’s separation from service.
6) Distributions made under an immediate annuity
contract.


The 59 ½ rule pertains to the age of the annuitant,
not the policy owner.
When does the 20% Mandatory Withholding apply?
◦ Distributions from qualified retirement plans or
tax sheltered annuities are subject to a
mandatory income tax withholding rate of 20%
unless the transfer is handled by means of a
direct rollover or transfer. (IRA’s and SEP’s are
exempt from this.)
Source: Internal Revenue Service Publication 575 – Pension and Annuity Income.
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice.
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Principal
Principal
Not Taxable,
No Penalty
Interest
Interest
Taxable +
Penalty
Accumulation
Withdrawal
The 10% penalty for withdrawals prior to age 59½ does not apply in the case of death, disability, or lifetime payouts. Withdrawals in excess of
the contract’s free amount may not be credited with interest for that term, are subject to withdrawal charges which may result in the loss of
principal if taken during the first 5-10 years of the contract. This material has been prepared for informational and educational purposes only.
It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
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Annuity
IRA
401(k)
Securities
Original
Investment
Not
deductible
Maybe
deductible
Made with
pre-tax
dollars
Not deductible
Earnings
Tax-deferred
Tax-deferred
Tax-deferred
Taxable unless
in tax-exempts
Distributions
Partially
taxable
Taxable,
except for
nondeductible
contributions
Taxable
Both earnings
and capital gains
are taxable
Estate Tax
Included in
gross estate
Included in
gross estate
Included in
gross estate
Included in gross
estate
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice. Tax consequences may vary by state.
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Annuitization
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Annuitization

At some point, the owner (or, after the owner’s death, the beneficiary) may
come to prefer to receive the value of the annuity as a stream of income

The owner can always choose to simply take partial withdrawals from the
annuity’s contract value instead of annuitizing the contract

Or, the owner can choose to “annuitize” the contract, that is, trade the
contract value to the insurance company in exchange for a guaranteed
stream of income
◦ After the trade, the account value becomes zero, but the insurance company is
obligated to make the promised payments
◦ Payments are made to the “annuitant,” who is usually the same person as the
owner
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Annuitization cont.
“Annuitization” or
Payout Period
Premium Payments
Growth Period
Annuity Starting Date:
Account Value is Traded In
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Annuitization Options

Life Only: The annuitant receives payments for as long as he or she lives
with all payments stopping when the annuitant dies.

Life with a Period Certain: The annuitant receives payments for as long
as he or she lives. If the annuitant dies within the certain period (for
example, 20 years), the remainder of the certain period payments will
continue to a stated beneficiary.

Period Certain: Rather than having payments tied to the lifetime of the
annuitant, the annuitant receives payments over the specified period
chosen. If the annuitant dies within the certain period, the remainder of the
certain period payments will continue to a stated beneficiary.
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Annuitization Options cont.

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Joint and Survivor: The annuitant and the chosen survivor receive the
annuity payments for as long as they are alive. Upon death of one of the
named individuals, a percentage of the annuity will continue to be paid to
the survivor for as long as he/she lives. The percentage can be as high as
100% of the payout or can be reduced to a lower selected percentage. The
spouse is the most commonly selected beneficiary.
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




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Account Value at the time of annuitization
Gender
◦ Statistics show that females live longer than males; therefore, the amount
paid monthly to a female is less than to a male.
Age
◦ The younger age at which a policy owner elects to “annuitize,” the longer
the payments will be made to the annuitant. The longer the payout
period, the lower the monthly payments.
Interest Rate
◦ The higher the interest rate the insurance company expects to earn after
the trade, the higher the initial monthly payments will be.
Annuity payout option
◦ The more guarantee chosen, the higher the minimum payout by the
insurance company, and the lower the monthly payments made to the
annuitant.
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Taxation After Annuitization

After annuitization, unless the annuity is part of a tax-qualified plan or an
IRA:

Each payment is taxed as partly interest and partly return of principal
◦ The “exclusion ratio” is the portion of each payment that is considered return of
principal and is thus not considered taxable income
◦ The remainder of each payment is considered interest and is thus reported as
taxable income
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice.
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
Exclusion Ratio formula
Investment in the Contract
EXCLUSION RATIO =
Expected Return
Investment in the contract is the total of premiums paid minus any interest received. This amount is also
minus any other amounts received under the contract that were excluded from gross income as a tax-free
recovery of cost basis. If the contract has a refund feature or unpaid policy loan, the investment in the
contract is reduced by the value of the refund feature or the unpaid loan.
Expected return is the estimated or actual amount to be received under the contract. For a fixed
annuity, simply multiply the periodic payment amount by the number of periods it will be paid, based on the
annuitants life expectancy. The expected return multiples are determined from the IRS tables or from the
installment amount and period, whichever is appropriate.
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon
for, accounting, legal, tax or investment advice.
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Premiums
(Accumulation Period)
Tax deferred
growth
Policy Owner or Annuitant
Income
(Payout Period)
•Greater income
•No greater tax
•Income that cannot
be outlived
•Creditor proof
Death benefit
paid to
designated
beneficiary(s)
Designated
in Agreement
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Insurance Company
Beneficiary(s)
This material has been prepared for informational and educational purposes only. It is not intended to provide, and should
not be relied upon for, accounting, legal, tax or investment advice.
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Summary
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The information contained herein is based on our current
understanding of federal tax laws as they relate to life
insurance and/or annuities or other subject matter
discussed. These laws are subject to change in the future.
Please consult your own personal advisor for legal, tax or
accounting advice.
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