AN AGE OF DECISION
Retirement today requires more planning than for
previous generations. Americans are living longer—
many will live 20 to 30 years or more in retirement.
Finding a way to make savings last over such a long
period of time is one of the biggest challenges of
today’s retirees.
In addition, sources of steady retirement income
have changed. Fewer workers are covered by
traditional employer-provided pension plans that
provide a lifetime benefit. Furthermore, Social
Security is not likely to provide future retirees the
level of benefits that it provides today. Americans
need other ways to create and guarantee lifetime
income so their standard of living doesn’t decline
with age.
To achieve a secure retirement, more and more
retirees are including an individual annuity in their
plans. An annuity can provide a steady stream of
income for life, shifting the burden of managing
savings from you to your life insurance company.
No other personal financial product offers this
guarantee of lifetime income. For many, the income
guarantee helps offset worries associated with
running out of money.
The American Council of Life Insurers has prepared
this guide to help retirees understand what an
individual annuity contract is, what options are
available, and how the right choice might enhance
retirement security.
Annuities are insurance contracts.
They come in different types and offer
many options to meet a variety of
financial objectives.
A deferred annuity can address
both pre-retirement savings and
post-retirement income needs. For
example, if you are years away from
retirement—or are retired and have
assets that don’t need to produce
income right away—a deferred
annuity allows your savings to
accumulate, tax deferred, until you
choose to receive income payments.
You decide how your money
accumulates—at a fixed interest rate,
an indexed interest rate, or based on
the performance of stocks and bonds.
You also select how you receive
income—in a lump sum, payments
over a specified number of years, or
steady income you cannot outlive.
If you need a guaranteed income
stream right away, an immediate
annuity converts an initial lump sum
of money into a series of monthly,
quarterly, or annual payments that
begin within a year after purchase.
You decide if you want to receive
those income payments over a
specified number of years or as a
steady stream of income you cannot
outlive.
Accumulation Options
For Deferred Annuities
Fixed Annuity
The money you put in a fixed annuity earns interest
at a rate that is guaranteed for a specific period
of time—ranging from one to five years or more,
depending on the terms of the contract. When that
period ends, a new rate may take effect—or the old
rate may be offered again. In no case will the new
interest rate be less than the guaranteed minimum
rate defined in the contract.
When you begin receiving income, a fixed payment
is guaranteed. Fixed annuities generally include
death benefit protection so that if you die before
payments begin, your beneficiary will receive at least
the amount you contributed minus any withdrawals
taken. These benefits are detailed in the annuity
contract.
Indexed Annuity
An indexed annuity is a type of fixed annuity. With
an indexed annuity, sometimes referred to as an
equity-indexed annuity, earnings accumulate at a
rate based on a formula linked in part to a published
equity-based index, such as the Standard & Poor’s
500 Composite Stock Price Index™ (S&P 500),
which tracks the performance of the 500 largest
publicly traded securities.
An indexed annuity provides a guarantee of a
minimum accumulation value, and may also offer
death benefit protection and a variety of payout
options.
The index used, the formula that determines the
indexed rate and the guaranteed minimum value, can
vary from insurer to insurer.
Variable Annuity
With a variable annuity, your money is put in
subaccounts that are invested in stock and bond
funds. You can respond to market conditions
by moving your money from one subaccount to
another—without incurring current taxes. The
return on your investments is subject to the risk of
market fluctuation. Your total account value depends
on how much risk you take, the performance
of the subaccounts, and what charges and fees
are deducted. These factors are explained in the
annuity’s prospectus, which outlines the objectives
and level of risk for each subaccount, operating
expenses, and financial statements.
Over the long term, variable annuities reflect
performance and growth in the economy and
may serve as an effective hedge against inflation.
However, it is possible to lose money in a variable
annuity. Some variable annuities allow you to place
some of your money in a fixed account with a
guaranteed rate of return. Such diversification helps
spread your risk. There are also optional guarantees
that can be purchased to provide additional
protection against downturns in the market.
Many variable annuities allow you to choose
between fixed or variable income payments.
A variable payment will fluctuate based on the
performance of the underlying subaccounts. Some
variable annuities guarantee that the payment will
not fall below a set amount.
Like a fixed annuity, if you die before payments
begin, your beneficiary may receive a death benefit,
which is typically the greater of either the current
account value of the annuity less withdrawals, or the
amount of your initial contribution.
Income Options
When you decide you want to receive income from
your annuity, a number of options are available.
Common options are:
􀁑 Life income—You receive income as long as you
live, even if payments exceed the amount of
money you put into the annuity. When you die, no
further payments are made to anyone. This
income option, also referred to as a straight
life option, usually provides the highest income
payment.
􀁑 Joint and survivor life income—This option
provides income for as long as you or the joint
annuitant live. Because the survivor feature is an
added benefit, the income payment is less than in
a straight life option.
􀁑 Life income with refund—You receive income for
life and, if you die before receiving the amount of
money you contributed, your beneficiary collects
the portion you had not yet received. Some
policies pay the beneficiary a lump sum, and
others may require benefits to be received in
installments.
􀁑 Life income with period certain—Payments
are made to you for as long as you live with the
guarantee that, if you die within a certain period
after you start receiving income (usually 10 or 20
years), your beneficiary will receive regular
payments for the rest of that period.
Other income options are available. You also can
choose to receive income in a series of payments
for a specified number of years, or if you have a
deferred annuity, in a lump sum. However, neither of
these options has a lifetime guarantee.
Many deferred annuities allow you to take money
out during the accumulation phase through periodic
or systematic withdrawals. There generally is a limit
on the amount you may withdraw each year
Costs and Fees
All financial products have costs associated with
them, and annuities are no different. An annuity is
an insurance contract that is unique in its ability to
guarantee a steady stream of income for life. This
and other insurance features, such as death benefits,
are included in the cost of the annuity.
In addition to the costs for insurance features, fees
may be charged if you withdraw some or all of
your money from your deferred annuity in the early
years. These fees are commonly referred to as
withdrawal or surrender charges. Often, after a time
specified in the contract, these fees are eliminated.
Some annuities waive these charges under specific
circumstances such as death, confinement to a
nursing home, or terminal illness. As mentioned
in the previous section, some deferred annuities
may allow annual withdrawals of a certain amount
without triggering a surrender charge.
Other fees also may apply, such as transaction,
market value adjustment, contract fees, and in the
case of a variable annuity, portfolio management.
Ask your agent or life insurance company for a
description of all applicable charges and fees.
Federal Tax Treatment
Earnings on a deferred annuity build up free of
current federal income tax. When you withdraw
money or receive income payments, the portion that
comes from earnings is taxed as ordinary income.
With an immediate annuity, you pay ordinary income
taxes on any earnings when you receive payments.
The portion of the payment that represents your
initial contribution is not taxed if your annuity was
purchased with after-tax dollars.
Because taxes are deferred until money is
withdrawn or received as income, there are tax
penalties for early withdrawal. If you choose to
withdraw money from your deferred annuity before
you reach age 59 1/2, you will trigger a 10 percent
tax penalty on the earnings portion of the amount
withdrawn plus the income tax due on earnings. The
tax penalty is not applied to certain lifetime payouts,
death benefits, or payments made if you become
disabled. Other exceptions may apply.
Annuity earnings also may be subject to state taxes,
which vary according to state. Check with a local tax
advisor for more information.
Before a Purchase
Both you, the purchaser, and the life insurance
company enter into to a long-term commitment
under an annuity contract. It is important to carefully
review your current finances, retirement goals, and
anticipated needs before you make a purchase.
To help you make an informed decision, consider
or discuss the following with a financial planner,
insurance agent, or broker.
Do you need to supplement current income?
You can convert assets to steady income right
away through an immediate annuity. Many retirees
purchase an immediate annuity with cash from a
retirement plan, the sale of a home, life insurance
benefits, or savings account. You choose whether
the income payments continue for a specified
number of years or for life.
Do you need less income in the early years of
retirement than you will in the future?
A deferred annuity allows your savings to grow—
tax deferred—until the date you decide to begin
receiving payments. An immediate annuity that
provides a cost of living adjustment also can address
this need.
What is your tolerance for risk?
In a deferred annuity, you decide whether savings
accumulate at a guaranteed rate, an indexed rate, or
bear the risk of market fluctuations.
Do you need to ensure income or asset
protection for a spouse after your death?
Certain annuities offer the option of continuing
income payments to a spouse after your death.
Some also provide death benefits if you die before
income payments begin.
If you are purchasing a fixed annuity, ask about
the current credited interest rate, how often it
changes, and the minimum guaranteed rate.
If you are purchasing an indexed annuity, find
out about the index, formula, and current factors
applicable to the initial indexed interest period.
Ask how often indexed interest is credited, how
factors may change in subsequent periods, and
level of minimum guaranteed values provided by the
contract.
If you are purchasing a variable annuity, review
the investment options currently available and
read the prospectus for each subaccount.
A prospectus, which is required to be given to
potential buyers, outlines the objectives and level
of risk, as well as operating expenses and financial
statements.
Ask if there are fees or charges for partial
withdrawal of funds or full surrender of your
deferred annuity contract. Find out how much the
fees are and for how long they apply.
Compare similar contracts from several
companies. Features, terms, and conditions vary
from company to company. Comparing contracts—
and the relative cost of features—may help you
make a better decision.
Ask if there is a guaranteed death benefit.
Some deferred annuities include death benefits
that may exceed the account value; some do not.
Know what benefit is guaranteed, how and when it
will be paid and whether increased benefits can be
purchased.
Ask how long the “free-look” period is. The
free-look period is the time you have the right to
review the contract and return it if you have made
the wrong choice. The company then will cancel
the contract and, depending on your state, refund
your initial contribution or the market value of the
contract. Free-looks usually last at least 10 days, but
rules vary from state to state and not every state
guarantees free-look rights.
Evaluate the company issuing the annuity.
Only life insurance companies can issue annuities,
although they may be sold by other financial
institutions such as banks and brokerage firms. Make
sure the issuing company is licensed in your state
and that the company is reputable, service oriented,
and financially strong. Several services rate the
financial strength of life insurance companies, such
as A.M. Best, Fitch Ratings, Moody’s, and Standard
& Poor’s. Ratings can be found in most public
libraries or on a service’s Web site (a small access
fee may be charged).
Make sure your agent is licensed to sell
annuities. To sell a fixed annuity requires only a
license issued by your state insurance department.
A variable annuity can be sold by a registered
representative of a broker-dealer that is a member
of the National Association of Securities Dealers
(NASD). The representative also must be licensed by
the state to sell variable insurance products.
Circular 230 disclosure: This document was not intended or written to be used, and cannot be used, to : (1)
avoid tax penalties, or (2) promote, market or recommend any tax plan or arrangement.
The American Council of Life Insurers (ACLI) is a Washington, D.C.-based trade association whose 356 member companies
account for 80 percent of the life insurance industry’s total assets in the United States. ACLI member companies offer life
insurance; annuities; pensions, including 401(k)s; long-term care insurance; disability income insurance; reinsurance; and other
retirement and financial protection products.
© 2005 American Council of Life Insurers, all rights reserved
101 Constitution Avenue, Suite 700, Washington, DC 20001–2133 www.acli.com