There’s a lot of buzz around annuity accounts now and for good reason. Fixed annuities are some of the safest and most secure investments available.
In a rising interest rate environment, these accounts protect and preserve wealth while providing guaranteed returns. They are also insured.
With so much interest, you’ll want to understand how these policies work. In this post, we explain the most common annuity terms and how they affect your invested dollars.
Owners, Annuitants and Beneficiaries Explained
Annuity policies begin with three main components. There is an owner, annuitant and a beneficiary.
Owner(s): All annuities have owners. There can be single or joint ownership. Often, we see spouses as joint owners. Additionally, we see entities as owners as well. An annuity can be owned by a corporation, trust, LLC, LLP or one of several other entities. (On a side note, these policies can also be used for IRA, 403b, 457 and other retirement accounts.)
Annuitant(s): An annuitant is the person the annuity is based on. Think of it as the person who’s insured – it’s based on his or her life. There can be joint annuitants (spouses), but they must be natural living people. Annuitants cannot be an entity like a corporation or a trust. In most cases the annuitant and the owner are the same person when corporate annuity owners are not used.
(The IRS has different taxation rules on some annuities based on your age, so it’s wise to consult a tax expert when investing.)
Beneficiaries: These are the people who inherit the account when the annuitant passes away. Like the owners, they can also be natural persons or entities. Some owners name their family members as beneficiaries while others use a trust, corporation or charity.
Consumers often create their accounts so their spouse has the option of continuing the annuity if the joint owner/annuitant passes prematurely. Policies allow for a lot of flexibility at onset.
Annuity Premiums And Bonus Accounts
The annuity premium is your initial investment into your account. Most contracts only accept one single premium, but others will accept funds for several years. Fixed, deferred income and immediate annuities are usually single premium accounts. Variable and indexed accounts usually accept additional deposits after onset.
Many contracts offer an annuity premium bonus. This incentive is usually associated with longer duration policies – say ten years. Some contracts will provide a bonus on your deposits for several years.
Terms, Account Value, Surrender Value and Death Benefit
The vast majority of annuities are offered for a set number of years. Often called the term, this period of time is established at purchase. It’s common to see fixed annuity accounts with two-, three- or five-year terms.
After the term has ended, the funds are free & clear of surrender charges. Some immediate annuity accounts have no defined term and simply provide income for the life of the owners.
The term of the annuity if usually called the surrender period. During this window, the owner will usually have access to their principal and interest, but not the entire principal. If the annuity is surrendered before the term is up, the owner will have to pay a surrender penalty. This amount is a percentage of the total account value and called the cash surrender value. It usually decreases each year.
Taking this a step further, your full account value is what your total investment is worth. However, it’s only available once your surrender period has ended (say five years, for example). Your full account value may also be available at death, when annuitized, or if you have certain health conditions. Otherwise, only the surrender value is available if you request all proceeds before your term is up.
Free Look Provisions And Contract Liquidity Definitions
Rules vary by state, but most annuity accounts allow the owner to inspect their contract for 30 days before taking possession.
This so-called free look period gives investors time to make certain the account best suits their needs.
After the free look window has ended, your annuity policy is considered an in-force contract.
The Contract Date (when the policy was issued by the insurance company) becomes effective and your surrender period has begun.
Account Liquidity, Terminal Illness And Chronic Condition Waivers
During the surrender period, most annuities offer several ways to access your funds without penalty. Oftentimes earned interest and a percentage of the principal are available in the first or second year of your policy term.
Other contracts will provide full or partial access to your account value should you be diagnosed with a chronic health condition or terminal illness. This is designed for those who might need large portions of their principal for long term care purposes.
Maturity Dates & Annuitization: Required To Annuitize?
There are common misunderstandings on how most annuities work. A couple of important definitions need to be addressed here.
The first term is: Annuitization. This is simply a guaranteed payment stream of principal and interest. There are several ways to set up these guaranteed payment streams, but most owners never take this option.
Your insurance company will not force you to annuitize your policy at the end of it’s term, however. You have the option to surrender your annuity and withdraw the entire account value. Alternatively, you can rollover, transfer or perform a 1035 tax-free exchange for a new annuity with terms/rates that meet your goals. It’s simply a choice.
Explaining Annuity Maturity Dates
If you’ve ever owned an annuity – or viewed a contract – you’ll notice it has a Maturity Date. Sometimes called an Annuity Date, this date is far off into the future and long past your surrender period.
This date is when the insurance company states your annuity payments can begin, if desired. It usually coincides with the annuitant’s 95th birthday. Are payments required? NO. Do you have to keep your policy that long? Also, NO.
Most annuity owners transfer their account or set up a new contract long before their maturity date. And if they have not, the insurance company will not force payments through annuitization. Instead, they allow you to change the maturity date and keep your annuity as is.
Guarantee Period & Minimum Guaranteed Rates
Most fixed annuity accounts have a Guarantee Period. This is simply the term that a certain interest rate is guaranteed. For instance, a MYGA (Multi-Year Guaranteed Annuity) might promise 4.00% for five years on your deposit. After that five-year term, the contract then matures.
Once mature, the annuity could have minimum guaranteed rate of 1%. At that time, it makes sense to look for a new annuity (or other investment) if the renewal rate is not competitive.
And almost all annuities have A Minimum Guaranteed Rate. This feature provides protection as it guarantees growth over the course of the annuity term. It’s only applied at the end of the term.
If, for example, your indexed annuity did not perform well over its seven-year term, the policy might guarantee 1% growth for each of the seven years. Again, this is only applied retroactively at the end of your chose term.
If the annuity is worth more than the Minimum Guaranteed Value at maturity, then that’s your cash value. In other words, it does not apply each year, but only when comparing the final values of the contract at the end of your chosen term.
Understanding Market Value Adjustments
Most fixed and indexed annuity accounts have a Market Value Adjustment (MVA) clause. It rarely comes into play, but it’s worth noting — especially in a rising interest rate environment.
Annuities are primarily constructed of bonds. This includes government treasuries, corporate debt offerings and some mortgage-backed securities. When rates go up, bond values go down. Conversely, when rates go down, bond prices go up.
Insurance companies build in MVAs to protect themselves and policyholders in the event there are mass liquidations in a rising rate environment. In practice, this means your annuity could be worth more or less based on interest rate fluctuations. (The MVA number is always available and usually on your annual statement.)
However, this repricing does not affect annuity values at maturity, death, or when normal distributions occur. It only affects any amount withdrawn during the surrender period above what is allowed for in the contract. In other words, it rarely comes into play unless it benefits the owner.
Contact Us For More Annuity Information
Hyers and Associates is an independent brokerage specializing in annuities for over 25 years. If you’d like to learn more about any of the definitions above, contact us today.
We’ll be happy to walk you through all of your best options when it comes to annuity investments.