Annuities
What are annuities?
An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-term goals. You buy an annuity by making a single lump-sum payment or series of payments. In return, the insurer agrees to make periodic income payments to you beginning immediately or at some future date. Alternatively, you may choose to withdraw your contract’s value as a lump sum payment, although doing so may subject you to surrender charges, taxes, and tax penalties.
Annuities are only appropriate for investors with a long-term investment time horizon.
Annuities provide:
- tax-deferred growth until you begin receiving income payments;
- the ability to receive a stream of income payments; and
- certain additional benefits that vary by contract.
Any annuity you select may have different costs, risks, and features, so it is important to review the materials you are given and discuss your questions with your financial professional.
When considering purchasing an annuity, it is important to remember that an insurance company’s obligations under an annuity contract are subject to its financial strength and claims-paying ability. In other words, if the insurance company has financial difficulties, it may not be able to pay you.
Why do people buy annuities?
What kinds of annuities are there?
What should I consider when buying or withdrawing money from an annuity?
What will I pay for my annuity?
What questions should I ask before buying an annuity?
Additional information
Why do people buy annuities?
People typically buy annuities to help manage their income in retirement. Annuities can provide three things:
- Tax-deferred growth. You pay no taxes on any interest or investment gains in your annuity until you withdraw the money, receive income payments, or a death benefit is paid.
- Guaranteed Income. You can receive periodic payments for a specific amount of time. This income may be for the rest of your life, the life of your spouse or partner, or some other set period of time.
- Death benefits. If you die before you start receiving payments, the person you name as your beneficiary receives at least the current value of the annuity, perhaps more.
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What kinds of annuities are there?
Annuities can be classified as either immediate or deferred.
With an immediate annuity, you make a single payment to purchase the annuity and typically start receiving income payments within one year of purchase. With a deferred annuity, you make a single payment or flexible payments over time that allow you to accumulate money for future income. The money you pay is allowed to grow tax-deferred before you start receiving income payments. This time period during which your money is allowed to grow is called the accumulation phase. For both types of annuities, the period when income payments begin is called the payout phase.
This page focuses on deferred annuities.
Four main types of deferred annuities
The four main types of deferred annuities are listed in order of increasing risk. Some deferred annuities are a combination of one or more of the below.
- Fixed annuities guarantee your money will earn at least a minimum interest rate during the accumulation phase. Fixed annuities may earn interest at a rate higher than the minimum but only the minimum rate is guaranteed. The insurance company sets the rates.
- Fixed indexed annuities earn interest during the accumulation phase based, in part, on the performance of a specified benchmark (e.g., the S&P 500 Index) at the end of a specified term (e.g., one year). The insurer credits interest to your annuity at the end of the term, and you do not know the interest rate in advance. The interest rate is guaranteed to never be less than zero, even if the market goes down.
- Registered index-linked annuities (RILAs) increase or decrease contract value during the accumulation phase based, in part, on the performance of a specified benchmark (e.g., the S&P 500 Index) at the end of a specified term (e.g., one year). Like a fixed indexed annuity, the insurer credits interest at the end of the term, and you do not know the interest rate in advance. However, unlike a fixed index annuity, you can lose money in a RILA. For example, the interest you are credited may be negative due to poor index performance. If there was negative index performance, the insurer may deduct money from your contract value. The insurer generally sets parameters that limit both your gains and your losses.
- Variable annuities allow you, during the accumulation phase, to direct your contributions to a menu of different mutual funds. There are no limitations on losses or gains, instead, your return is based on the performance of the funds.
Fixed Annuities | Fixed Indexed Annuities | Registered Index-linked Annuities (RILAs) | Variable Annuities | |
| What are the common features of annuities? |
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What is the potential for the growth of your investment?
| Guaranteed growth at a fixed rate of interest. | Growth potential is tied to an index’s performance, but with limits on how much you can earn. | Growth potential is tied to an index’s performance, but with limits on how much you can earn. | Growth potential is based on the performance of the mutual funds selected. |
| What is the potential for the loss of money? | Generally none, other than a surrender charge for withdrawals or surrenders you take during the surrender charge period. | Generally none, other than a surrender charge for withdrawals or surrenders you take during the surrender charge period. | There is a potential for loss of your investment:
| There is a potential for loss of your investment:
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| What are the ongoing fees? | Reflected in the interest rate. | Reflected in the limits on how much you can earn. | Method varies by product. May be reflected in limits on how much you can earn, explicit fees, or both. | There are explicit fees charged both under the contract and by the underlying mutual funds. |
| How risky is this annuity compared to the others? | Least risky (and has lowest potential return). | Riskier than a fixed annuity (but has more potential return). | Riskier than a fixed annuity and a fixed indexed annuity (but has more potential return). Some index-linked options offered under the contract may even have unlimited risk (with higher potential return). | Most risk (potentially unlimited risk) (but highest potential return). |
What regulator do I contact with complaints?
| An insurance product. Regulated by state insurance regulator. Contact the State insurance commission | An insurance product. Regulated by state insurance regulator. Contact the State insurance commission | An insurance product and a security. Regulated by state insurance regulator and registered with the SEC. Contact the SEC. | An insurance product and a security. Regulated by state insurance regulator and registered with the SEC. Contact the SEC. |
| What type of investor buys this annuity? |
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Annuities that are securities
Some annuities are securities as well as insurance products.
These annuities must register with the SEC and are subject to securities laws and regulations. Annuities that register with the SEC will have prospectuses. If you are considering purchasing an annuity through an investment professional such as a broker or an investment adviser, you can check out individuals and their firms using our Check Out Your Investment Professional search tool to see if they are registered with us and if they have any disciplinary history.
Of the four main types of deferred annuities shown above, RILAs and variable annuities are securities that must register with the SEC.
Another type of deferred annuity that is a security required to register with the SEC is a registered market value adjustment (MVA) annuity. In a registered MVA annuity, the insurer pays a fixed rate of interest over a specified period, but may adjust the value of your contract, often down, if you withdraw money early.
What should I consider when buying or withdrawing money from an annuity?
Buying
Before you buy an annuity:
- Carefully read any information provided to you. The information may include an annuity contract and any prospectus.
- Ask questions about what you don’t understand.
- Consider consulting a financial professional about whether the annuity's features, benefits, risks, and fees are appropriate for you based on your financial situation and goals.
Once you buy your annuity:
- Read any additional information provided to you.
- Be sure the information in these documents matches your understanding of the annuity.
- Ask your financial professional to explain anything you don’t understand.
What if I change my mind?
State law gives you a set number of days (usually 10 to 30 days) to change your mind about buying an annuity after you receive the annuity contract. This often is called a "free look" period. Your contract should prominently state how long your free look period is and how to return your contract.
Withdrawals and Surrenders
Many deferred annuities let you withdraw money during the accumulation phase. If you take all of your money out at once, this is often called a “surrender” and terminates the annuity. You may also be able to take out part of your contract value.
There may be adverse consequences to taking money of out of your annuity, including:
- Surrender charges. If you take a withdrawal of some or all of your contract value within a certain number of years of purchasing or contributing money to your annuity, the amount withdrawn may be subject to a surrender charge. Surrender charges will reduce the value of -- and the return on -- your investment.
- Taxes. Withdrawing money from your annuity may be a taxable event. Also, if you withdraw money before age 59½, you may have to pay tax penalties.
- Contract Adjustments. Some annuities earn interest over a specified term. If money is withdrawn or transferred from an investment option before the end of the term, you may forfeit any interest that may have been earned during the period. The insurer may also adjust the value of your annuity through a Market Value Adjustment or an Interim Value Adjustment. These contract adjustments are often negative and may significantly lower the value of your annuity. They are in addition to any surrender charge that applies. Both RILAs and registered MVA annuities contain contract adjustment features.
- Reducing certain benefits. Withdrawing money may reduce the value of your benefits (such as death benefits). The value of the benefit may even be reduced by more than the amount you withdraw.
Exchanges
An exchange means you use the contract value of one annuity to purchase another annuity. If you follow certain tax rules, an exchange for one annuity for another may not trigger a taxable event. Instead, the tax deferral continues under the new contract.
Be careful if a financial professional suggests an annuity exchange. Some financial professionals may have a financial incentive to offer you a new annuity in place of the one you own. Only exchange your contract if you determine, after comparing the features, fees, rates, and risks of both contracts, that it is preferable for you to purchase the new annuity rather than continue to own your existing annuity. When exchanging your annuity, you may be subject to a surrender charge when exiting your old annuity. Upon exchange, you may also be subject to a new surrender charge period associated with your new annuity.
Annuities and retirement plans
Be cautious if a financial professional suggests you purchase an annuity within a tax-deferred retirement plan, such as a traditional 401(k) or traditional IRA. Ask how the annuity fits into your overall financial situation.
One advantage of an annuity is that your money in the annuity grows tax free during the accumulation phase. But if you are investing in an annuity through a tax-deferred retirement plan, you do not get any additional tax deferral. The annuity will be taxed like any other investment in the plan.
What will I pay for my annuity?
Fees reduce the value of your annuity regardless of how you pay them. To pay for an annuity, the insurer may subtract some fees directly from your annuity’s value. These fees are called explicit fees. Some annuities include implicit costs that are harder to identify, but also reduce the value of your annuity. In both cases, these are indirect fees that you won’t directly see a bill for. But you will likely receive an account statement reflecting any explicit fees deducted from your annuity.
Implicit costs and fees - what do they mean for me?
Many fixed annuities, fixed indexed annuities, and RILAs do not charge explicit ongoing fees.
But, implicit fees may be reflected in the amount of interest credited to the contract. For example, the insurer may credit you with less interest than it earns on your contributions to the contract, or it may limit the gains your annuity may earn.
What this means:
- In a fixed indexed annuity, for example, an insurer may credit you 3% interest while it earns 4% interest on your investment.
- In a fixed indexed annuity or a RILA, the insurer may place caps that limit the amount of positive gains your annuity can earn. These limits are imposed in return for the downside protection provided and the other costs of offering the annuity.
These implicit costs can reduce your return in the same way that a direct or explicit fee would.
Ongoing Fees
- Base contract fees –A base contract fee is often calculated as a percentage of your contract value. For example, if your base contract fee is 1.25% and the current value of your annuity is $300,000, your annual fee would be $3,750. This fee is deducted from the returns of the investment options and pays the issuer for the insurance risk it assumes under the annuity contract. The profit from this fee sometimes is also used to pay a commission to the financial professional who sold you the annuity.
- Underlying fund fees - In a variable annuity, you will also indirectly pay the fees for the mutual funds that you pick as your investment options. These are in addition to the base contract and other fees charged by the insurer and are deducted from the returns of the investment options.
- Optional benefit fees. Some annuities offer optional benefits. You will typically pay additional fees for these features. They can include enhanced death benefits and guaranteed minimum income benefits.
- Penalties. If you withdraw money from an annuity before you are age 59 ½, you may have to pay a 10% tax penalty to the Internal Revenue Service on top of any taxes you owe on the withdrawal.
- Implicit fees. See the box above regarding implicit fees.
Transaction Fees
- Surrender Charge. As discussed above, many annuities charge a fee if you take part or all the money out of your annuity within a certain number of years of purchasing or contributing money to the annuity. Generally, these fees decrease over time.
- Contract Adjustments. As discussed above, some annuities adjust the value of your contract if you withdraw or transfer money before the end of a specified period. These adjustments, also known as Interim Value Adjustments or Market Value Adjustments, are often negative and can result in significant loss in the value of your annuity. These adjustments are in addition to any surrender charge that may also be applicable.
Taxes
You may want to consult a tax adviser about the tax consequences of investing in an annuity. The federal tax rules that apply to annuities can be complicated. Tax laws and tax rates also change over time. In addition, there may be state tax implications.
What questions should I ask before buying an annuity?
- What type of annuity is suitable for my financial goals?
- Ask about the different types of annuities available (fixed, fixed indexed, RILA and variable) and determine which one aligns with your specific needs and objectives.
- What are the fees associated with the annuity?
- Ask about any fees (upfront, surrender, ongoing, or implicit) or other limits on investment performance to help you assess the overall impact on your investment returns.
- Do I intend to keep my money in the annuity long enough to avoid paying any surrender charges, tax penalties, or any contract adjustments?
- Ask about how long you must hold your annuity to avoid charges and penalties and maximize the value of your investment.
- How does the annuity's interest rate or investment performance work?
- Understanding how your investment options work will help you gauge the potential growth and risks of your investment.
- What is the annuity's death benefit?
- Ask about the death benefit provided by the annuity, including how it is calculated (both during the accumulation phase and payout phase) and what happens to the annuity in the event of your passing. Understand how your beneficiaries will receive the proceeds and any potential tax implications.
- What optional benefits, if any, are offered with the annuity?
- Consider whether there is a fee to purchase the benefit, or if you will be charged an ongoing fee during the time that you have optional benefit.
- Make sure you understand the conditions required to maintain the benefit (e.g., are you only permitted to allocate your contract value to specified investment options?).
- Ask about the likelihood of actually receiving the benefit. For example, some “guaranteed benefits” provide contingent guarantees, meaning they are designed to protect you from an unlikely event (such as severe market losses and/or outliving your assets due to a very long life) and while they may provide peace of mind, you may be paying for a benefit that will not provide a financial return.
- What is the financial strength and reputation of the insurance company offering the annuity?
- Consider the financial strength and customer service record of the insurance company providing the annuity. Ensure they have a solid reputation and the ability to fulfill their financial obligations to you over the long term.
- How does the annuity fit into my overall financial plan?
- Consider how the annuity fits into your broader financial strategy. Assess its alignment with your goals, risk tolerance, cash needs, and other investments you own.
If you don’t know the answers or have other questions, ask your financial professional for help.
Additional information
Updated Investor Bulletin: Indexed Annuities
Updated Investor Bulletin: Variable Annuities
