Single Premium Deferred Annuities

Deferred Annuities Made Simple

How Annuities Are Inherited

Annuities are common retirement investments most of which can designate a beneficiary. To be clear, annuities are contracts made for a promise of repayment in the future between an investor and an insurance company. Like other investments, the gains made on the annuity accounts over time, stay with the actual contract. However, the gains made when someone inherits the annuity, is treated as normal income and is taxed at the new owner’s tax bracket.

The inheritance of an annuity can be complicated when it comes to taxes. For example, if you were to inherit a fixed annuity which was purchased with after tax dollars you, and you took a lump-sum payment you would owe taxes on the funds you receive. Generally, however, the person inheriting the funds can take out the entire worth of the annuity all at once, a bit every month, periodically, or wait for up to five years, while the money in the account continues to accumulated with deferred taxes. This last option would allow for tax-deferred growth of the funds in the account. To increase your level of options to withdraw annuity funds inherited, one would need to take the money out of the annuity within five years of the inheritance. In any of the options, the funds withdrawn will be taxed in the individual’s tax bracket.

Depending on the annuity and depending on what option for withdrawing the funds are chosen and spelled out in the contract, the tax burdened may be calculated differently. Nevertheless, the insurance company would be able to assess the tax and any fee obligations for new owner in a clear manner. The new owner is ultimately responsible for paying taxes as it were income when it is withdrawn. The tax would include the obligation on the accumulated gains that the account has received or will continue to receive, if the account is not withdrawn immediately.

A spouse may choose to inherit the annuity altogether in a process known as “spousal continuation.” If this is the case the spouse may be able to make good on the tax deferred status. In either case, either the spouse or the beneficiary will have to supply a death certificate and fill out the necessary paperwork to prove the death of the annuity owner. The decision to withdraw funds can depend on a number of factors for the beneficiary and what he or she is willing to stomach when it comes to the taxman. A lump sum payment may spare the need for complicated taxes, as the person inheriting the annuity will be taxed immediately. The problem with that is that the lump sum amount my kick the beneficiary up into a new tax bracket, which will result in him more taxes overall. If this is the case, he could elect to withdraw the taxes in percentages that would allow him or her to stay within his tax bracket and allow him to gain further accumulation of funds from the money that is still in the annuity.

There may be restrictions on single premium indexed annuities on beneficiaries. Some contracts restrict the ability to inherit the funds altogether, so it would be strongly recommended to review the contract with your insurance agent to ensure the right kind of investment the investor needs for him and his family. With careful planning inheriting an annuity doesn’t have to be as difficult as it may seem. It is best to talk with an insurance agent to understand the obligations on the investor’s part and what the options are for those that inherit the funds are.

Understanding Deferred Annuities

While annuities have been around for centuries as a way to provide a guaranteed income stream, deferred annuities are a relatively new variation that offers a savings component. For people, who didn’t have an immediate need for income, life insurers came up with a way for them to “defer” the income into the future while providing them with a way to accumulate the capital needed for the income.

Deferred annuities became a preferred savings instrument during the Great Depression when savers lost confidence in the banking system. At the time, life insurance companies were considered to be much more financially stable than the banks, and people were looking for alternative ways to save for their retirement. In the last 80 years, deferred annuities have grown in popularity and they continue to form the foundation of millions of people’s retirement plan.

Deferred Annuity Basics

To better understand deferred annuities, it is helpful to understand immediate annuities, which are based on the original annuity concept. With people living longer, the growing fear among retirees is the prospect of outliving their income source. An immediate annuity is a form of insurance that protects against that possibility. It is, essentially, a contract between a life insurance company and an individual in which the insurer, in exchange for a lump sum deposit, guarantees an income stream for a specific period of time, or for the life of the individual.

One way to think of a deferred annuity is that it is a savings component that has been added to the front of an immediate annuity. The lump sum deposit is placed into an account that accumulates interest for the period of time the investor has to save before requiring the income. Because it is an insurance contract, deferred annuities have some very unique characteristics which make them very attractive retirement planning tools.

Deferred Annuity Characteristics

Fixed rate annuities offer competitive interest yields that are guaranteed for varying lengths of time. Typically, the longer the guarantee period is, the higher the yield. Unlike bank CDs which offer yields based on market interest rates, annuity rates are based on the yield that a life insurance company generates from its investment portfolio which consists of a basket of interest bearing securities such as long term bonds. Based on the actual performance of their investments, life insurers can potentially generate higher yields than are available from market interest rates.

Variable Rates

Some deferred annuities offer investors the opportunity to invest in separately managed accounts consisting of stock and bond portfolios. The rate that is credited to the account is based purely on the performance of the portfolios, so while the potential is there to earn higher rates of return, so is the risk of loss in the portfolio’s value.

Guaranteed Minimum Rate

For fixed rate annuities, the contracts include a minimum rate that is guaranteed to be credited even if the yield falls below it. This feature is what makes fixed rate deferred annuities more predictable as a retirement planning tool. With variable annuities, a minimum rate guarantee can be purchased as an option which provides insurance against market risk.

Tax Deferral

Perhaps the number one reason why deferred annuities have gain in popularity over the years is the fact that they are favored by the tax code which allows the account values to grow without incurring taxes. They are treated similarly to qualified retirement accounts, such as IRAs, in that the tax is only applied when funds are withdrawn. It is then that they are taxed as ordinary income. For people in high tax brackets, deferred annuities offer an opportunity to accumulate funds more quickly.

Account Access

Deferred annuities are considered to be long term investment vehicles, and investors should be willing to commit their funds for the duration in order to realize their maximum benefits. Still, they also include provisions for accessing funds in the near term should it be necessary. Generally, investors can withdraw up to 10% of their account value each year without incurring a charge. Any withdrawals that exceed 10% will be charged a fee if it is made within the surrender period, which can be as long seven to ten years.

The fees start as high as 10% and then are reduced be a point each year until it falls to zero. So, in this example, all of the account values can be accessed after 10 years without a charge, however, if done so prior to the age of 59 ½, the IRS may assess a 10% penalty unless certain requirements are met.

Guaranteed Death Benefit

A distinguishing feature of deferred annuities is the guaranteed death benefit which ensures that the beneficiaries will receive no less than the principle amount of the annuity should the annuity owner die prematurely. This feature is especially valuable for variable annuity owners who would otherwise risk leaving less money than they originally invested if their separate accounts didn’t perform well. In both cases, many deferred annuities include an option or a provision that also protects the gains of the account values.

Fees and Expenses

All of the benefits that deferred annuities provide don’t always come without a cost. The primary expense common to all annuities is the cost of insurance, or the mortality expense which covers the insurers risk in providing the guaranteed death benefit. Variable annuities also have investment management fees that pay the expenses associated with the professionally managed accounts. Administrative fees are sometime charged to cover record keeping and service costs. Some annuities are sold with front end sales charges; however, there are a growing number of annuity products that are sold with no sales loads as well.

How the Distribution Phase Works

After a sufficient amount of capital has been accumulated, and additional income is needed by the investor, a deferred annuity can be converted into an immediate annuity. When that happens, the total account balance is turn over to the insurer, irrevocably, so that the insurer can commit to a schedule of period payments that are guaranteed for a lifetime, or some specified period of time. This is known as the distribution or income phase of an annuity.

To determine the amount of income that the recipients, or annuitants, will be paid, the life insurer takes into account the total capital that is available, the age of the annuitant, the minimum interest rate, and the length of the income period. The length of the income period can be a specific number of years, or the life expectancy of the annuitant. Using standard life expectancy tables, the insurer determines the number of years an annuitant is expected to live which becomes the income period.

Income Payout Rate

Applying those factors, the insurer then establishes a payout rate which, for a fixed annuity, is set for the income period. A variable annuity may have a variable pay out based on the fluctuation of the underlying investments. The payout rate is a combination of the principle balance and interest or gains, so a portion of the income received is a return of principle which is not taxed.

Refund option

In its most basic form, an annuity is designed to pay an income on the life of an individual. But when that individual dies, the income stops, and the remaining account balance is retained by the life insurer. If annuity owners want to have all or portions of the remaining account balance go to a beneficiary, they can select from a number of refund options that will pay the proceeds in installments. The cost to add these options is paid by reducing the payout rate.

For married annuitants, the spouse becomes the automatic beneficiary, and with most contracts, the annuity payments will continue to the spouse. If a joint life payment option was selected, the annuity payments will continue through the death of the second spouse.

Finding Top Indexed Annuities

Just when we thought we were beginning to understand how annuities worked, along came indexed annuities to, once again, make us feel a little inadequate. The good news is that they provide investors with a very good alternative to lower yielding fixed annuities and the more risk-oriented variable annuities. The problem is that they are much more difficult to understand because they utilize several factors to determine the actual yield that is credited. If you’re trying to determine how to find the best indexed annuities, this guide will help tell you what you should look for when comparing them.

Indexed Annuity Basics

Essentially, indexed annuities are a variation of fixed annuities, but instead of a single fixed interest rate credit, the actual credited yield is based on either the percentage gain in one of the stock indexes, or a minimum fixed interest rate, whichever is greater. From here it gets a little convoluted so, pay attention.

Most indexed annuities are linked to a specific stock index, such as the S&P500. From the moment your funds are deposited, the movement of the stock index is tracked, so that, at the end of one year, if the index shows a percentage gain (i.e. up 10%), your account is credited a return based on a portion of that percentage gain. The credited portion is determined by applying to key factors: a participation rate and a rate cap. After they are applied, a net rate of return is credited to your account which is always lower than the actual percentage gain of the index. If the index shows a percentage decline (i.e. down 10%), a minimum rate guarantee kicks in, which guarantees that your account will not lose value.

That’s the thirty thousand foot overview, but the devil is in the details. Understanding these factors and how they are applied is key to determining which indexed annuities are the best for your particular situation.

Indexed Annuity Components

Index Link

The first important consideration is deciding which market index you want your account values to follow. The S&P 500 is a broad stock market index comprised of larger capitalized companies. It may be more stable than another index that is comprised of smaller companies that have more growth potential, but also more volatility. Some indexed annuities have a blend of indexes for even greater diversification. The key is to choose the index, or mix of indexes that most closely matches your investment preferences.

Participation Rate

The participation rate is the percentage of the gain that will be credited to your account. The rate can range from as low as 25% to as high as 90%. So, if the percentage gain in the stock index is 20%, and the participation rate is 70%, your credited rate, before the rate cap is 14%. The life insurance company keeps the other portion to offset its costs.

It would seem that the best strategy would be to consider indexed annuities with the highest participation rate. While that may be a good place to start, be aware that some products offer a very high participation rate as an enticement, but then drop the rate after a year. It may be better to consider products that offer a lower initial rate, but with a long term rate guarantee.

Rate Cap

A rate cap, which is essentially a maximum allowable rate that can be credited, is applied after the participation rate. These rates can range from 4% to as high as 15% depending on several factors, such as the participation rate and the length of the surrender period. Some contracts don’t have a cap rate at all, but their participation rates are very low. So, if after the participation rate is applied, the net return is 14%, a 10% cap rate would mean that the account is credited with 10%. The life insurance company retains the remainder of the gain as a way to create the reserves necessary to protect your values in a market decline.

Obviously, the higher the cap rate, the better, but it may not be if the participation rate is too low. It may be better to choose a contract with a higher guaranteed participation rate and a lower cap rate. Either way, it is important to know whether or not they are guaranteed or subject to change. Typically, contracts that have longer surrender periods will offer higher cap rates.

Floor Rate

Up to this point, the contract rates have been chipping away at your return, but they are there, in part, so that you can have a floor rate which is your downside protection. The floor rate is the minimum rate that can be credited to your account no matter how much the stock index declines. These rates can range from 0% to 3%. While 0% may not seem so great, it is still the assurance that your principle will not lose value. Always go with the higher floor rate, but be sure to check to see how long it is guaranteed.

Credit Period/Method

Your account value is credited once per year using one of four methods:

Annual rest: The actual year-over-year percentage gain, after the participation rate and rate cap are applied, is credited to your account which is then reset so that the increased value becomes the new basis in the contract. This ensures that your account value will never drop.


Similar to the annual reset except that the reset period consists of multiple years, typically five years.

High watermark

This method looks back on the year to apply the highest gain achieved during the year.

Monthly averaging

The position of the index is tracked each month of the year, added together, and then divided by 12 to determine the yield.

Of the four, the annual reset is the more appealing option. You will tend to find the point-to-point method used more often.

Surrender Period

Although most indexed annuities are sold without a sales load or commission, the life insurance company recovers some of its selling costs through surrender fees. A surrender fee applies when a withdrawal that exceeds 10% of the account value is made during any year in the surrender period. The fees can be as high as 15% and the surrender period can last as long as 15 years. Typically, the surrender fee is reduced by a percentage point each year and is scheduled to drop to zero by the end of the surrender period.
It is not uncommon to see indexed annuities with higher participation rates, or rate caps, or floor rates also have longer surrender periods and higher fees. However, if you aren’t concerned with the longer commitment of your funds, you will tend to benefit by choosing contracts with longer surrender periods.

Compare, Compare, Compare

With these key components as your criteria, you can more easily conduct a side-by-side comparison of indexed annuity contracts. One important factor to keep in mind is the strength and stability of the life insurance company that is backing the contract guarantees and your principle. You are probably much better off looking at the products issued by the most highly rated companies.

How to Find the Best Deferred Annuities

Since they reached their peak in popularity back in the high interest rate days of the 1980’s, the number of deferred annuities on the market have proliferated creating, at best, a seemingly unlimited number of choices, and, at worst, a tremendous about of confusion. Wading through the hundreds of different deferred annuity products is, for most people, a daunting task, at best. If you are wondering how to find the best deferred annuities, use this guide to help save you time and frustration.

Key Characteristics of the Best Deferred Annuities

The deferred annuity market is constantly changing so it may never be possible to know if you have found the very best one. But, by applying some key criteria, you can easily narrow down the choices to include only those annuities that might rank on most people’s top ten list, which is about as good as it can get. Here is a list of the most important criteria for finding the best deferred annuity:

Rates that Make You Smile

Deferred annuity rates are very competitive from one product to the next, but, generally, their rates are a bit higher than other fixed yield vehicles such as bank CDs. So, if you have decided to invest in a deferred annuity over a CD, that alone should make you smile. But, if you are on the hunt to find the best interest rate available on a deferred annuity, you may be in for a little work.

Annuity interest rates can be searched and compared fairly easily on the internet. Once there, it is important to determine whether or not you are comparing apples and apples. Interest rates will vary depending on a number of factors such as the length of the surrender period or guarantee period. Typically the longer the rate guaranteed period, the higher the interest rate. Annuities with higher rates tend to have longer surrender periods, so all factors need to be weighed.

Also, many deferred annuities offer a bonus rate which is usually only applicable in the first year. It is important to read the fine print to see how the rate is adjusted after that. The same with rate guarantee periods. A high rate may be guaranteed for a few years, but then it will be adjusted downward. You need to know how that adjustment is determined.
Depending on how all of the factors weigh out, the better annuity may be the one with the slightly lower rate, but longer guarantee period, with a higher minimum rate guarantee and a reasonable surrender period. To find the best deferred annuities all factors need to be considered.

Financial Strength that Helps You Sleep

The highest interest rate in the world could have dubious value, if it is credited by a life insurance company deemed to have potentially serious financial problems in the future. The extra half of a percentage point is never worth the loss of sleep that would bring. Annuities are contracts between individuals and life insurance companies with a promise to deliver on several guarantees such as a return of principle and a minimum rate of interest. The security of that promise rests almost exclusively on the financial capabilities of the life insurance company.

While the life insurance industry is solid as a whole, as compared to other financial institutions, only the strongest companies will be able to weather the worst of economic storms, at least according to the independent rating firms such as A.M. Best, Standard & Poor’s and Moody’s. Essentially, any rating less than an ‘A’ is considered suspect by all three. With dozens of companies earning better than an ‘A’ rating it makes almost no sense not to focus your search on the upper tier of companies. Commons sense will tell you that the best deferred annuities are the ones that are best positioned to deliver on their promise.

Prioritize Your Search

With these two key criteria as your starting point, the search for the best deferred annuities becomes more streamlined. Starting with the financial quality of the issuing companies, you should be able to narrow your choices instantly. The higher your financial quality standard is the more narrow the field. Start with companies that are ‘A’ rated or better. You will find that, by the time you select out all of the companies except those with A+ (A.M. Best) or AA (Moody’s, S & P), you will still have more than thirty companies from which to choose.

Moving to the rates, you can compare them side-by-side using the key factors: Initial rate guarantee, length of guarantee period, minimum rate guarantee. You can also add in the bonus rate, but that should be considered after comparing the first three factors.
Once you have narrowed the field to ten or less, you can then start to peer into some of the other features such as their surrender period and fees. While this may not be a concern for long term investors, the notion of having greater access to funds increases the “peace-of-mind” quotient. So, those annuities with shorter surrender periods or lower surrender fees may move them up in your ranking. It’s not uncommon for deferred annuities with shorter surrender periods to have lower initial rate or minimum rate guarantees as an offset.


How often do we actually find the best of anything? The “best” is a really a subjective measure, but, for each of us individually, it is based on some very specific criteria that guides us in our search. Finding the best deferred annuities is no different. The more you know about your own financial needs, preferences and priorities, the better positioned you will to match yourself with the best annuity for you.

How To Find the Best Indexed Annuities

In the 1990s, indexed annuities burst on the scene as the answer for investors who were gun-shy about variable annuities, but not satisfied with the low yields available on fixed annuities. Their appeal was heightened as the volatility of the stock market increase throughout the decade of the 2000s. And, as their popularity grew, so did the controversy surrounding them due to their complexity. As more indexed annuity products were released in the marketplace they became much more competitive, which made it increasingly difficult to find the best indexed annuities.

There are a lot of factors that need to be considered when trying to find the best indexed annuity product, and, while it is difficult to find the best of anything, there are certain indicators that can be used to narrow down the choices. The first indicators to consider are the key features that go into making indexed annuities work the way they do.

Key Features of Indexed Annuities

Stock Index Yields

Indexed annuities are, essentially, fixed yield investments much like fixed annuities, in that the annuity accounts are credited each year with a fixed rate of return. The difference is in how the yield is determined.

In a fixed annuity, the yield is based on the investment performance of the life insurer’s bond portfolio. A portion of the yield generated from the portfolio is credited to the annuity accounts. In an indexed annuity, the yield is based on the percentage gain of one of the major stock indexes.

The various indexed annuities all link to one of any number of stock indexes that track different baskets of stocks. The S & P 500 index tracks large cap and blue chip stocks which are more stable and growth oriented. There are other stock indexes that track other market segments which can offer greater upside potential, but are also more volatile. So, the best indexed annuity for you would be the one that uses a stock index that best meets your investment preference.

Participation Rate

The percentage gains in the stock index are shared between you and the life insurer. Your share, is based on the participation rate the insurer establishes in the contract. The rate varies from one contract to another, and can be as high as 90% or as low as 25%. If the rate on your contract is 80%, then you would receive 80% of the percentage gain.

Obviously, the higher the participation rate, the better for you, however, it would be important to check the rate against two other factors: 1) How long the rate is guaranteed. If it is a “teaser” rate, it may only be good for a short period after which it can drop, and 2) How high or low the rate cap is set (discussed next). A high participation rate with a low rate cap, may not be beneficial to you in the long run.

Rate Cap

Because the life insurer assumes all of the downside risk of indexed annuities, they limit your participation in the gain and they also limit yield that is credited to your account. Rate caps are established in the contract, and can also be adjusted. The caps can range anywhere from 15% to 4%. An 8% cap would mean that, even if the gain in the index is 20%, and, after your participation rate (i.e. 80%) is applied, your portion is 16%, your credited rate will be capped at 8%.

Again, a higher rate cap would be more beneficial to you, however, you should read the fine print to see if there are any adjustments to the cap.

Minimum Rate Guarantee

Your rate may be capped on the upside, but it is also capped on the downside, which, for many investors, is a pretty good tradeoff. Your account will never earn less than the state minimum interest rate which can range from 0% to 3%. While you should always consider products with higher minimum rate guarantees, it shouldn’t be at the expense of a higher participation rate or rate cap. A 0% rate guarantee might not be so bad if you have a higher rate cap and participation rate.

Annual Reset

As an added layer of protection, indexed annuities include a reset mechanism which, in essence, adjusts the basis in your contract to reflect the gains achieved in the prior year. Your account value will never be adjusted down, always up.

There are several different reset methods applied by life insurers. The most favorable method is the annual reset, which applies the gains made from anniversary to anniversary. The more widely used method is “point-to-point” which applies the gains made over a multiple number of years, say, 5 years.

Financial Backing

The great appeal of indexed annuities, for most investors, is the risk free aspect of participating in stock market gains with preservation of principal. Of course, that can only be accomplished if the life insurer who is backing your principal, and guaranteeing the minimum returns, has the financial strength and integrity to withstand even the worst economic storms.

An indexed annuity with the highest participation rate, rate cap and minimum rate guarantee would be a “fail” if the issuing life insurance company was unable to fulfill its obligations due to insolvency. While that has rarely happened (life insurers are very strictly regulated and must maintain adequate reserves), it may not be worth the sleep loss for an extra half of a percent in yield if the issuing life insurer has a questionable financial condition.

There are no perfect 10s in life. In most cases, several factors need to be rated and weighted in determining the best product for your particular needs. For instance, if your greatest concern is peace-of-mind and the financial strength of the issuing life insurer, a “10” rating for financial quality would weigh much more heavily against a “7” rating for the participation rate. The best indexed annuity is the one that rates most favorably overall based on your own criteria.