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Annuities Overview

 

Definition: What Is an Annuity?

An annuity is a contract between an individual ("annuitant") and an insurance company.  The annuitant agrees to pay the insurance company a single payment or a series of payments, and the insurance company agrees to pay the annuitant an income, starting immediately or at a later date, for a specified time period.  Under current tax law, money put into an annuity grows on a tax-deferred basis until the annuitant begins receiving his accumulated fund as an income.  That means that one hundred percent of your earnings are reinvested in an annuity and allowed to compound-- or grows -- without having to pay taxes on earnings.

Most Common Usage

Long considered a CD alternative, annuities have become very popular today. Paying higher rates than CD's and deferring taxes, many people on a fixed income find annuities are a better option than tying up money in CD's or letting it warehouse in a money market account.. Like a CD, you can place lump sums of money in annuities. You must leave the money in the annuity for a period of years. The longer you leave the money in, the higher your interest rate will be. Depending on the annuity purchased, a yearly amount is allowed to be withdrawn without a penalty. This amount is usually around 10%.

There are other annuity options, such as fixed payment annuities and even equity-indexed annuities. These other options are explained below.

How Long Have Annuities Been Around?

Annuity comes from the Latin word annuus, meaning yearly. Originally it referred only to a sum that was payable once a year. Today, the word annuity can mean both income paid on a regular schedule (an immediate annuity), and a type of retirement savings plan (a deferred annuity) that offers flexible purchase and withdrawal options, including—appropriately—one that pays income on a regular schedule.

Babylonian landowners invented them in 2500 B.C., by setting aside the income from a piece of farmland to reward someone for the rest of his life. Today’s annuities may substitute money for farmland to reward someone for the rest of his life. The first annuity written in America was over 200 years ago and modern annuities have grown on a tax-deferred basis since passage of the modern income tax code in 1913.

Two Main Annuity Types: Immediate and Deferred

The difference between deferred and immediate annuities is just about what you'd think.

With an immediate annuity (see below), your income payments start right away (technically, anytime within 12 months of purchase). You choose whether you want income guaranteed for a specific number of years or for your lifetime. The insurance company calculates the amount of each income payment based on your purchase amount and your life expectancy.

A
deferred annuity (see below) has two phases: the accumulation phase, where you let your money grow for a while, and the payout phase. During accumulation, your money grows tax-deferred until you take it out, either as a lump sum or as a series of payments. You decide when to take income from your annuity and therefore, when to pay the taxes. Gaining increased control over your taxes is one of the key benefits of annuities.

The payout phase begins when you decide to take income from your annuity. For most people, this is during retirement. As your needs dictate, you can take partial withdrawals, completely cash-out (surrender) your annuity, or convert your deferred annuity into a stream of income payments (annuitization). This last option is essentially the same as buying an immediate annuity.

IRA Qualified Annuities

Like many Americans, you may own an IRA. One of the most common misconceptions among IRA owners is that they must keep their IRA where it is; when in fact, nothing could be further from the truth. 

As an owner of an IRA, you have complete control over where you want to invest your IRA funds. Especially if you are unhappy with its current rate of return or the service you are receiving from the institution where your IRA is presently held. You can transfer your IRA to another IRA qualified investment without penalty or having to pay any income tax. This is done via an IRA Rollover or a Direct Transfer (see below).

Additionally, annuity products are a safe and secure alternative - and with interest rates that are better than most bank CDs, Savings Accounts or Money Market Funds. Also, if your IRA is currently in a Mutual Fund and you are concerned about the risk to your principal, an Annuity is an excellent way to guarantee your principal with an opportunity for greater growth. 

In these uncertain times, protecting your nest egg and earning a competitive return on your IRA is more important than ever. With annuity products offered by PCIS, your IRA funds grow without the risk associated with the stock market and at a higher interest rate than is generally offered by Bank CDs, Savings Accounts or Money Market Funds!

How Do I Complete an IRA Rollover or Direct Transfer?

IRA Rollover
If you want to rollover an IRA, either Traditional or Roth, you need to request a check from the current custodian or institution that handles your IRA. The check received could be made payable to you personally. You are then free to do what you want with that money. As long as you put the money from the old IRA into a new IRA within 60 days, your IRA remains intact and you won't owe any federal income tax or tax penalties on the money. So, as you can see, it's important to make sure that the money is put back into your new IRA account within 60 days. The IRS allows you to "Rollover" your IRA in this fashion, once every 12 months.

Direct Transfer
In many cases you may wish to transfer your money directly from one IRA custodian to another. By doing a "Direct Transfer" you avoid the risk of owing any federal income tax or tax penalties and you don't have to worry about the 60-day requirement. Unlike a "Rollover", which can only be completed once every 12 months, the IRS does not limit the number of times you can "Transfer" your IRA.

Immediate Annuities

Single Premium Immediate Annuities (SPIAs) are purchased by a single deposit. They usually start making regular monthly payments to you immediately after the date you make that deposit. The key ingredient for an immediate annuity is the exchange which takes place between the insurance company and the buyer. The company promises to pay a monthly income for the life of the annuitant and the buyer gives up his rights to ever receiving his deposit back in a lump sum. Once an immediate annuity makes its first payment, it generally cannot be cashed in.

An immediate annuity can be purchased with funds from a variety of possible sources, such as: a maturing Certificate of Deposit (CD); monies which have accumulated in a Deferred Annuity account (see below); or funds from a tax-qualified defined benefit or profit-sharing plan, or from an IRA account.

Why should I consider buying an Immediate Annuity?

What are its advantages to me?

Immediate annuities provide many advantages to the buyer, such as: (1) Security - the annuity provides stable lifetime income which can never be outlived or which may be guaranteed for a specified period; (2) Simplicity - the annuitant does not have to manage his investments, watch markets, report interest or dividends; (3) High Returns - the interest rates used by insurance companies to calculate immediate annuity income are generally higher than CD or Treasury rates, and since part of the principal is returned with each payment, greater amounts are received than would be provided by interest alone; (4) Preferred Tax Treatment - it lets you postpone paying taxes on some of the earnings you’ve accrued in a "tax-deferred" annuity when rolled into an immediate annuity (only the portion attributable to interest is taxable income, the bulk of the payments are nontaxable return of principal); (5) Safety of Principal - funds are guaranteed by assets of insurer and not subject to the fluctuations of financial markets; and (6) No sales or administrative charges.

SPIAs are particularly suitable for providing income in the following situations: (1) Retirement from Employment; (2) Terminal Funding or Pension Terminations (including deferred commencements); (3) Retired Life Buyouts; (4) Professional Sports Contracts; and (6) Credit Enhancement and Loan Guarantee Transactions.

Forms of an Annuity

In its simplest form - the Straight Life or Non-refund immediate annuity - payments are guaranteed over the lifetime of one person. This form of annuity insures the recipient against outliving his financial resources and is an important instrument in planning for retirement. Given a fixed deposit amount, the monthly payments which derive from a "Life" annuity are always greater than those derived from other forms of immediate annuity, such as the "Life with Period Certain" annuity, or the "Joint and Survivor" annuity. The insurer of a single life annuity calculates its obligation only until the last regular payment preceding the annuitant’s death. With other more extended forms of annuity, the insurer calculates its risk over a longer period than the one life expectancy, and reduces accordingly the monthly payment amount. However, because the payments on a single life annuity expire when you do, selecting this form of annuity is, in a sense, a bet that you expect to live longer than the average person.

When you extend the range of a life annuity by continuing payments to a second person ("Joint and Survivor" annuity) or for a guaranteed minimum period of time ("Period Certain" annuity), the extra coverage may reduce the monthly payment by about 5% to 15%. Several situations where these "extended" forms of immediate annuity would be most suitable are: (1) when the income needs to be guaranteed over the lifetimes of a husband and wife ("Joint and Survivor" annuity); (2) when payments must continue for a specified period (e.g. 5 or 10 years or more) to a designated beneficiary ("Certain and Continuous" annuity); or (3) when the annuitant wants to make sure that, if he should die before his full investment has been distributed in monthly payments, an amount equal to the balance of the deposit continues to a named beneficiary ("Installment Refund" annuity).

 Immediate Annuity Definitions

Period Certain Only Annuities

5-Years Period Certain (Without Life Contingency): Level payments are received for 5 years. If the annuitant should die before the end of the certain period, payments will be paid to the designated beneficiary. No payments are made to the annuitant after the end of the specified period. (You may outlive this type of annuity.)

10-Years Period Certain (Without Life Contingency): Level payments are received for 10 years. If the annuitant should die before the end of the certain period, payments will be paid to the designated beneficiary. No payments are made to the annuitant after the end of the specified period. (You may outlive this type of annuity.)

15-Years Period Certain (Without Life Contingency): Level payments are received for 15 years. If the annuitant should die before the end of the certain period, payments will be paid to the designated beneficiary. No payments are made to the annuitant after the end of the specified period. (You may outlive this type of annuity.)

20-Years Period Certain (Without Life Contingency): Level payments are received for 20 years. If the annuitant should die before the end of the certain period, payments will be paid to the designated beneficiary. No payments are made to the annuitant after the end of the specified period. (You may outlive this type of annuity.)

Single Life Annuities

Single Life Only, Without Refund: Level payments are received for the annuitant’s lifetime and cease upon the annuitant’s death.

Single Life with 5-Years Certain (aka 5-Years Certain & Continuous): Level payments are received for the annuitant’s lifetime. However, if the annuitant should die before the end of 5 years, payments will be paid to the designated beneficiary until the end of the 5 year period.

Single Life with 10-Years Certain (aka 10-Years Certain & Continuous): Level payments are received for the annuitant’s lifetime. However, if the annuitant should die before the end of 10 years, payments will be paid to the designated beneficiary until the end of the 10 year period.

Single Life with 15-Years Certain (aka 15-Years Certain & Continuous): Level payments are received for the annuitant’s lifetime. However, if the annuitant should die before the end of 15 years, payments will be paid to the designated beneficiary until the end of the 15 year period.

Single Life with 20-Years Certain (aka 20-Years Certain & Continuous): Level payments are received for the annuitant’s lifetime. However, if the annuitant should die before the end of 20 years, payments will be paid to the designated beneficiary until the end of the 20 year period.

Single Life with 25-Years Certain (aka 25-Years Certain & Continuous): Level payments are received for the annuitant’s lifetime. However, if the annuitant should die before the end of 25 years, payments will be paid to the designated beneficiary until the end of the 25 year period.

Single Life with Installment Refund: Level payments are received for the annuitant’s lifetime. However, if the annuitant should die before receiving an amount equal to the original premium, the periodic payments will continue to be paid to the designated beneficiary until the total payments made (annuitant and beneficiary) equal the original premium (without interest).

Single Life with Cash Refund: Level payments are received for the annuitant’s lifetime. However, if the annuitant should die before receiving an amount equal to the original premium, the difference between the premium and the total payments received will be paid in one lump sum to the designated beneficiary.

Joint & Survivor Annuities

Joint & Survivor (50%...75%) reducing on FIRST or EITHER death: Full level payments are made as long as both the annuitant and joint annuitant are alive. Upon the death of either the annuitant or joint annuitant, reduced (50%...75%) level payments will continue to the survivor for as long he/she is alive.

Adding a Period Certain provision to a Joint & Survivor (50%...75%) annuity accomplishes the following: Even if the annuitant or joint annuitant dies before the end of the certain period, payments to the survivor will not reduce until after the end of the certain period (5-25 years). If both the annuitant and joint annuitant die before the end of the certain period, full level payments will be paid to the designated beneficiary until the end of the certain period.

Joint & Survivor (50%...75%) reducing ONLY ON DEATH OF PRIMARY ANNUITANT: Full level payments will be made for as long as both the annuitant and contingent annuitant live. Payments are never reduced to the Primary Annuitant. Payments are reduced to the Contingent annuitant should the Primary Annuitant predecease the Contingent Annuitant. (Note: This form is sometimes called Joint and Contingent annuity. However, be careful, many companies interchange their definitions for Joint and Survivor and Joint and Contingent forms. Verify that your company’s interpretation of a survivor annuity is what you have in mind to purchase.)

Adding an Installment Refund provision to a Joint & Survivor (50%...75%) annuity does the following: Full level payments will be made for as long as both the annuitant and contingent annuitant live.  Depending on whether the annuity is of the Joint & Survivor or Joint and Contingent type (see above), payments may reduce upon the death of either annuitant or only if the primary annuitant predecease the contingent Annuitant. However, if both the primary annuitant and joint annuitant should die before receiving in periodic payments an amount equal to the original premium, then the periodic payments continue to be paid to the estate or designated beneficiary until the total payments made (to both annuitants while living and to the beneficiary after the annuitants' deaths) equals the original premium (usually, without interest).

Adding a Cash Refund provision to a Joint & Survivor (50%...75%) annuity does the following: The only difference between this option and the Installment Refund provision is that if both the primary annuitant and joint annuitant should die before receiving in periodic payments an amount equal to the original premium, then the difference between the original premium (usually, without interest) and the periodic payments received during the annuitants' lifetimes, is paid to the estate or designated beneficiary in a single lump sum.

Adding a Period Certain provision to a Joint & Contingent (50%...75) annuity does this: If the annuitant dies before the end of the certain period, payments to the contingent annuitant will not reduce until after the end of the certain period (5-25 years). If both annuitants die before the end of the certain period, full level payments will be paid to the designated beneficiary until the end of the certain period.

Joint & Full Survivor (100%): Level payments are made for as long as either the annuitant or joint annuitant is alive.

Joint & Survivor (100%) with Certain Period: Adding a Period Certain provision to a Joint & 100% Survivor annuity does this-- If both the primary annuitant and joint annuitant should die before the end of the specified certain period (5-25 years), full level payments will be paid to the designated beneficiary until the end of the certain period.

Joint & Survivor (100%) with Installment Refund: Adding an Installment Refund provision to a Joint & 100% Survivor annuity does the following-- Level payments are received for the annuitants' lifetimes. However, if both the primary annuitant and joint annuitant should die before receiving in periodic payments an amount equal to the original premium, then the periodic payments continue to be paid to the estate or designated beneficiary until the total payments made (to both annuitants while living and to the beneficiary after the annuitants' deaths) equals the original premium (usually, without interest).

Joint & Survivor (100%) with Cash Refund: Adding a Cash Refund provision to a Joint & 100% Survivor annuity does the following-- Level payments are received for the annuitants' lifetimes. However, if both the primary annuitant and joint annuitant should die before receiving in periodic payments an amount equal to the original premium, then the difference between the original premium (usually, without interest) and the periodic payments received during the annuitants' lifetimes, is paid to the estate or designated beneficiary in a single lump sum.

Funds That Purchase an Immediate Annuity

Source of Funds - Qualified vs. Non-Qualified

The term Qualified (when applied to Immediate Annuities) refers to the tax status of the source of funds used for purchasing the annuity. These are premium dollars which until now have "qualified" for IRS exemption from income taxes. The whole payment received each month from a qualified annuity is taxable as income (since income taxes have not yet been paid on these funds). Qualified annuities may either come from corporate-sponsored retirement plans (such as Defined Benefit or Defined Contribution Plans), Lump Sum distributions from such retirement plans, or from such individual retirement arrangements as IRAs, SEPs, and Section 403(b) tax-sheltered annuities, or Section 1035 annuity or life insurance exchanges. Generally speaking, insurance companies use male/female (sex-distinct) rates to price qualified annuities in situations where the purchaser and/or owner is a corporation. When the annuity is being purchased by an individual, annuity rates are generally unisex. Some states, however, require that unisex rates be used for all qualified annuities.

Non-qualified immediate annuities are purchased with monies which have not enjoyed any tax-sheltered status and for which taxes have already been paid. A part of each monthly payment is considered a return of previously taxed principal and therefore excluded from taxation. The amount excluded from taxes is calculated by an Exclusion Ratio, which appears on most annuity quotation sheets. Non-qualified annuities may be purchased by employers for situations such as deferred compensation or supplemental income programs, or by individuals investing their after-tax savings accounts or money market accounts, CD’s, proceeds from the sale of a house, business, mutual funds, other investments, or from an inheritance or proceeds from a life insurance settlement. While most insurance companies apply their male/female (sex-distinct) tables to non-qualified annuities, some states require the use of unisex rates for both males and females.

 Fixed Tax Deferred Annuities

What is a Fixed Tax-Deferred Annuity?
A Fixed Tax-deferred annuity, also referred to as a tax-deferred annuity, is a contract between you and an insurance company for a guaranteed interest bearing policy with guaranteed income options. The insurance company credits interest, and you don't pay taxes on the earnings until you make a withdrawal or begin receiving an annuity income. Your annuity contract earns a competitive return that is very safe.

Tax-Deferred?
Tax-deferred means postponing your taxes on interest earnings until a future point in time. In the meantime you earn interest on the money you're not paying in taxes. You can accumulate more money over a shorter period of time, which ultimately will provide you with a greater income.

Savings Advantages
Many people today are using tax-deferred annuities as the foundation of their overall financial plan instead of certificates of deposit or savings accounts. Although CD's and Annuities are very similar there are significant differences between the two. The most important difference is that annuities allow for the deferral of the taxes due on the interest earned until the interest is withdrawn! By postponing the tax with a tax-deferred annuity, your money compounds faster because you can earn interest on dollars that would have otherwise been paid to the IRS. Later, if you decide to take a monthly income, your taxes can be less because they will be spread out over a period of years. Like Certificates of Deposits, annuities have a penalty for early surrender, however most annuity contracts have a liberal "free withdrawal" provision.

Tax Advantages
You pay NO taxes while your money is compounding. You can also pay a lower tax on random withdrawals because you control the tax year in which the withdrawals are made, and only pay taxes on the interest withdrawn. Tax deferral gives you control over an important expense - your taxes. Any time you control an expense, you can minimize it. The longer you can postpone this particular expense, the greater your gain when compared to the gain you would make with a fully taxable account.

The Tax-Deferred Advantage
To illustrate the increased earnings capacity of tax-deferred interest, compare it to fully-taxable earnings. $25,000 at 6.0% will earn $1,500 of interest in a year. A 28% tax bracket means that approximately $420 of those earnings will be lost in taxes, leaving only $1,080 to compound the next year. If these same earnings were tax-deferred, the full $1,500 would be available to earn even more interest. The longer you can postpone taxes, the greater the gain.

Safety
Your tax-deferred annuity is safe. A qualified legal reserve life insurance company is required to meet its contractual obligations to you. These reserves must, at all times, be equal to the withdrawal value of your annuity policy. In addition to reserves, state law also requires certain levels of capital and surplus to further increase policyholder protection. Legal reserve refers to the strict financial requirements that must be met by an insurance company to protect the money paid in by all policyholders. These reserves must be at all times, equal to the withdrawal value (principal plus interest less early withdrawal fees, if any) of every annuity policy. State insurance laws also require that a life insurance company must maintain certain minimum levels of capital and surplus, which provide additional policyholder protection.

No More 1099's
There is no withholding tax while your annuity is compounding; it is completely tax-deferred. If you request a distribution (random withdrawals or annuity income), taxes will be withheld - unless you elect differently. Your election not to withdraw can be made at the time you make your request. Because the interest is tax-deferred, it is not necessary to issue a Form 1099 while your money is compounding. Only when your interest is distributed (withdrawal or annuity income) will a Form 1099 be sent, reflecting the amount of interest actually received.

When Does My Money Mature
An annuity policy does not "mature" like a bond or certificate of deposit.  Both your principal and interest will automatically continue to earn interest until withdrawn or you reach age 100. You can let your money continue to grow, make withdrawals, or begin receiving an annuity income at any time.

What is the Penalty Tax and When Does it Apply?
An IRS penalty tax, currently 10%, will be payable on any withdrawal of interest or qualified premium made prior to age 59 1/2.

Avoid Probate
If a premature death should occur, the accumulating funds within your annuity may be transferred to your named beneficiaries, avoiding the expense, delay, frustration and publicity of the probate process. Like most assets, the annuity is part of your taxable estate. Your heirs can chose to receive a lump sum payment, or a guaranteed monthly income.

 Equity-Indexed Annuities Explained

An equity-indexed annuity is an annuity that earns interest that is linked to a stock or other equity index. One of the most commonly used indices is the Standard & Poor's 500 Composite Stock Price Index (the S&P 500).

HOW ARE THEY DIFFERENT FROM OTHER FIXED ANNUITIES?

An equity-indexed annuity is different from other fixed annuities because of the way it credits interest to your annuity's value. Most fixed annuities only credit interest calculated at a rate set in the contract. Equity-indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how the additional interest, if any, is calculated and credited. How much additional interest you get and when you get it depends on the features of your particular annuity.

Your equity-indexed annuity, like other fixed annuities, also promises to pay a minimum interest rate. The rate that will be applied will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower. The value of your annuity also will not drop below a guaranteed minimum. For example, many single premium annuity contracts guarantee the minimum value will never be less than 90 percent (100 percent in some contracts) of the premium paid, plus at least 3% in annual interest (less any partial withdrawals). The insurance company will adjust the value of the annuity at the end of each term to reflect any index increases.

WHAT ARE SOME OF THE CONTRACT FEATURES?

Two features that have the greatest effect on the amount of additional interest that may be credited to an equity-indexed annuity are the indexing method and the participation rate. It is important to understand the features and how they work together. The following describes some other equity-indexed annuity features that affect the index-linked formula.

Indexing Method
The indexing method means the approach used to measure the amount of change, if any, in the index. Some of the most common indexing methods, which are explained more fully later on, include annual reset (ratcheting), high-water mark and point-to-point.

Participation Rate
The participation rate decides how much of the increase in the index will be used to calculate index-linked interest. For example, if the calculated change in the index is 9% and the participation rate is 70%, the index-linked interest rate for your annuity will be 6.3% (9% x 70% = 6.3%). A company may set a different participation rate for newly issued annuities as often as each day. Therefore, the initial participation rate in your annuity will depend on when it is issued by the company. The company usually guarantees the participation rate for a specific period (from one year to the entire term). When that period is over, the company sets a new participation rate for the next period. Some annuities guarantee that the participation rate will never be set lower than a specified minimum or higher than a specified maximum.

Cap Rate or Cap
Some annuities may put an upper limit, or cap, on the index-linked interest rate. This is the maximum rate of interest the annuity will earn. In the example given above, if the contract has a 6% cap rate, 6%, and not 6.3%, would be credited. Not all annuities have a cap rate.

Floor on Equity Index-Linked Interest
The floor is the minimum index-linked interest rate you will earn. The most common floor is 0%. A 0% floor assures that even if the index decreases in value, the index-linked interest that you earn will be zero and not negative.

Averaging
In some annuities, the average of an index's value is used rather than the actual value of the index on a specified date. The index averaging may occur at the beginning, the end, or throughout the entire term of the annuity.

Margin/Spread/Administrative Fee
In some annuities, the index-linked interest rate is computed by subtracting a specific percentage from any calculated change in the index. This percentage, sometimes referred to as the "margin," "spread," or "administrative fee," might be instead of, or in addition to, a participation rate. For example, if the calculated change in the index is 10%, your annuity might specify that 2.25% will be subtracted from the rate to determine the interest rate credited. In this example, the rate would be 7.75% (10% - 2.25% = 7.75%). In this example, the company subtracts the percentage only if the change in the index produces a positive interest rate.

HOW DO THE COMMON INDEXING METHODS DIFFER?

Annual Reset
Index-linked interest, if any, is determined each year by comparing the index value at the end of the contract year with the index value at the start of the contract year. Interest is added to your annuity each year during the term.

High-Water Mark
The index-linked interest, if any, is decided by looking at the index value at various points during the term, usually the annual anniversaries of the date you bought the annuity. The interest is based on the difference between the highest index value and the index value at the start of the term. Interest is added to your annuity at the end of the term.

Point-to-Point
The index-linked interest, if any, is based on the difference between the index value at the end of the term and the index value at the start of the term. Interest is added to your annuity at the end of the term.

WHAT ARE SOME OF THE ADVANTAGES AND DISADVANTAGES OF DIFFERENT INDEXING METHODS?

Generally, annuities offer preset combinations of indexing features. You may have to make trade-offs to get features you want in an annuity. This means the annuity you choose may also have some features you don't want.

Advantages

Disadvantages

Annual Reset

 

Since the interest earned is "locked in" annually and the index value is "reset" at the end of each year, future decreases in the index will not affect the interest you have already earned. Therefore, your annuity using the annual reset method may credit more interest than annuities using other methods when the index fluctuates up and down often during the term. This design is more likely than others to give you access to index-linked interest before the term ends.

Your annuity's participation rate may change each year and generally will be lower than that of other indexing methods. Also, an annual reset design may use a cap or averaging to limit the total amount of interest you might earn each year.

High-Water Mark

 

Since interest is calculated using the highest value of the index on a contract anniversary during the term, this design may credit higher interest than some other designs if the index reaches a high point early or in the middle of the term, then drops off at the end of the term.

Interest is not credited until the end of the term. In some annuities, if you surrender your annuity before the end of the term, you may not get index-linked interest for that term. In other annuities, you may receive index-linked interest, based on the highest anniversary value to date and the annuity's vesting schedule. Also, contracts with this design may have a lower participation rate than annuities using other designs or may use a cap to limit the total amount of interest you might earn.

Point-to-Point

 

Since interest cannot be calculated before the end of the term, use of this design may permit a higher participation rate than annuities using other designs.

Since interest is not credited until the end of the term, typically six or seven years, you may not be able to get the index-linked interest until the end of the term.


WHAT IS THE IMPACT OF SOME OTHER PRODUCT FEATURES?

Cap on Interest Earned
While a cap limits the amount of interest you might earn each year, annuities with this feature may have other product features you want, such as annual interest crediting or the ability to take partial withdrawals. Also, annuities that have a cap may have a higher participation rate.

Averaging
Averaging at the beginning of a term protects you from buying your annuity at a high point, which would reduce the amount of interest you might earn. Averaging at the end of the term protects you against severe declines in the index and losing index-linked interest as a result. On the other hand, averaging may reduce the amount of index-linked interest you earn when the index rises either near the start or at the end of the term.

Participation Rate
The participation rate may vary greatly from one annuity to another and from time to time within a particular annuity. Therefore, it is important for you to know how your annuity's participation rate works with the indexing method. A high participation rate may be offset by other features, such as averaging, or a point-to-point indexing method. On the other hand, an insurance company may offset a lower participation rate by also offering a feature such as an annual reset indexing method.

HOW DO I KNOW WHICH EQUITY-INDEXED ANNUITY IS BEST FOR ME?

As with any other insurance product, you must carefully consider your own personal situation and how you feel about the choices available. No single annuity design may have all the features you want. It is important to understand the features and trade-offs available so you can choose the annuity that is right for you. Keep in mind that it may be misleading to compare one annuity to another unless you compare all the other features of each annuity. You must decide for yourself what combination of features makes the most sense for you. Also, remember that it is not possible to predict the future market behavior of an index.

 

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