1035 Exchange: A tax-free transfer of an annuity contract or life insurance policy from one insurance company to another. Typically done when an annuity has performed poorly, or to obtain a higher rate of return or more attractive features. Although 1035 transfers are tax-free, the annuity holder may owe a surrender charge if the surrender period has not yet lapsed.
Accumulation Phase: The accumulation phase is the period in which the cash value of the annuity is increasing, as annuity premiums are paid and investment returns are accumulating. See also Annuitization phase.
Actuary: A professional who uses statistical techniques to determine the probability of a financial event occurring (such as how long an annuity holder or life insurance policyholder is likely to live), and the cost of providing coverage for that event, including insurance and annuity payouts.
Anniversary Date: The anniversary of the date on which an annuity contract begins. Indexed annuities typically calculate the annuity’s annual return based on the change in the S&P 500 index between anniversary dates.
Annual Reset: In the context of annuities, this refers to the way the return on an indexed annuity may be calculated. When an indexed annuity has an annual reset, the growth (return) is measured annually, and the return from previous years is locked in.
Annuitant: The individual who receives the payments from an annuity, according to the terms of the contract. Usually, the owner and the annuitant are one and the same.
Annuitant-driven: Annuity contracts with provisions that are triggered by the status of a designated individual (the annuitant). Aside from the death of the annuitant, becoming disabled or reaching a specified age can activate certain contract provisions.
Annuitization: The process of converting an annuity contract’s value (the lump sum paid upfront) into an income stream consisting of periodic payments made over a specified period of time, or until the death of the annuitant.
Annuity: A contract in which a lump sum of money paid upfront is invested and transformed into a series of ongoing guaranteed minimum payments that are made periodically (often monthly or quarterly) to an annuitant. Payments are made for a set period of time or may be structured to last until the individual dies.
Annuity Certain: An annuity that provides payments for a defined period of time. If the annuitant dies before the period ends, his or her estate or beneficiaries receive the remaining payments.
Annuity Contract: A legal contract in which an insurance company promises to make periodic payments to a designated individual beginning on a set date over a specific period of time, or for the rest of the individual’s life, in exchange for an upfront premium or series of premiums paid to the insurer.
Annuity Period: The period of time over which the annuity payments are made (see also Accumulation Phase).
Assumed Investment Rate: The minimum rate of return that must be obtained on the money invested in an annuity to cover its guaranteed future payments, as well as associated administrative costs and a profit for the insurance company that issued the annuity.
Bailout Provision: A provision that allows an annuity owner to surrender part or all of the contract (withdraw the cash value), usually without charge, when certain conditions are met. The bailout option is triggered when a minimum rate of return drops below a certain level. Bailout provisions are typically for fixed annuities with guaranteed minimum returns, where the investments that support the contracts are fixed income securities like US Treasuries, not in stock market investments.
Beneficiary: The individual or legal entity (e.g., an estate) that receives an annuity death benefit when the annuitant designated in the contract dies. The beneficiary cannot manage the annuity; that right belongs to the contract owner.
Bonus Annuity: Can be a fixed or variable annuity that provides the annuity buyer with a bonus, typically from 2% to 10%, in addition to the return earned by the annuity (either variable, indexed or fixed rate, depending upon the type of annuity). An annuity can have a one-year bonus period or multi-year bonus periods. Usually, the bonus is advertised as a way of offsetting a surrender charge if an annuitant moves the annuity to another insurer.
Certificate Annuity: An annuity in which the interest rate guarantee period is equal to the surrender charge period.
Charitable Gift Annuity: An annuity in which a donor makes a gift of property or investments to a charity in exchange for a partial tax deduction and a lifetime stream of income from the charity. The guarantee is backed by the charity’s assets, not by an insurance company.
Co-Annuitants: The annuitants specified in an annuity structured to pay lifetime benefits as long as one of the two individuals is alive. The annuity contract terminates when the second of the co-annuitants, usually a married couple, dies.
Confinement Waiver: An feature that allows an annuity’s surrender charges to be eliminated if the owner is hospitalized or requires care in a long-term care facility. Typically involves a 60- or 90-day waiting period to qualify for the waiver.
Contract Owner: The person or entity that buys an annuity contract. This is the party responsible for funding the annuity. An owner can be an individual, couple, partnership, corporation, or trust. The owner and the annuitant are usually the same person, but not always.
Contract Termination: The end of an annuity, occurring when the specified payment period ends, or the annuitant dies.
Contract Value: The total of annuity premiums paid plus investment returns, less any charges, withdrawals, or fees.
Death Benefit: The remaining value of the annuity payments due, paid to the designated beneficiary (or beneficiaries) if the annuity contract owner dies before the guaranteed payment period ends.
Deferred Annuity: An annuity that allows the buyer to invest in an annuity today and accumulate investment returns tax-free until the annuity payments begin, on a date after the annuitant has reached a minimum retirement age.
Equity Indexed Annuity: A type of (fixed) annuity that earns a return linked to a stock market index, such as the S&P 500 (Standard & Poor’s 500 Composite Stock Price Index). This type of annuity offers a minimum guaranteed return plus some percentage of the return on the index (e.g., 3% minimum + 80% of the S&P 500 index return).
Exclusion Ratio: Specifies the taxable and non-taxable portions of annuity payments. Part of each payment is considered a return of principal (the amount paid when the annuity was purchased) and is therefore not subject to taxation. The remainder consists of investment earnings, which are taxable.
Fixed Annuity: An annuity contract that provides a guaranteed rate of return on the funds invested in the annuity. A fixed annuity is more conservative (less risky) than a variable annuity, and therefore tends to offer a lower return.
Flexible Premium: An annuity that allows the buyer to add to the principal (to increase the amount invested in the annuity) multiple times in the future. After paying the initial premium, additional premiums can be contributed to the same annuity instead of setting up a new annuity.
Flexible Premium Deferred Annuity (FPDA): An annuity in which the owner has the option to invest additional premiums to the annuity (see flexible premium) in the future, and which delays the periodic payouts for some period after the final premium is paid, allowing investment returns to compound for longer.
Forced Annuitization: Many annuities require the Payment Period to begin by the time the annuitant reaches a certain age, often between 85 to 95. When annuity owners reach the maximum allowed age they are required to select a payout option. This generally terminates any death benefits under the annuity.
Free Look Provision: This provision in an annuity contract states that the annuity buyer has between ten and 20 days after buying the annuity to review the contract and cancel it for a total refund. The terms of this provision are governed by state regulations, which vary across states.
Free Withdrawal Provision: This provision in an annuity contract allows the owner to withdraw part of the accumulated value annually, typically 10%, during the accumulation period, without having to pay a withdrawal charge. Intended to help annuity holders facing a financial emergency.
Guaranteed Interest Rate: The minimum interest rate or investment return an insurer will credit to an annuity’s value during the annuity contract’s accumulation phase. This minimum guaranteed rate changes based on the rate of interest (yield) available on US Treasury securities and other very low risk investments.
Guaranteed Minimum Surrender Value: Fixed-indexed annuities have a
Guaranteed Minimum Surrender Value (GMSV) to prevent the value of the annuity from declining (after surrender charges are subtracted) when the annuity earns a 0% return due to a flat or declining stock market. Contract holders will receive no less than the GMSV for surrenders, annuitizations and death benefits.
Immediate Annuity: An annuity that begins making payments immediately or within a year of the date the contract is established.
Income or Payout Options: Refer to the various ways the owner of an annuity contract may choose to receive income from that annuity. Options include: (1) Income for a guaranteed period(see Period Certain annuity), where a specific payment is guaranteed for a set period of time (usually from five years to 30 years). If the annuitant dies before the end of the period, a beneficiary receives the remaining payments for the guaranteed period; (2) Lifetime payments, which guarantees payments for life, with no survivor benefit. Payments are based on how much is invested, investment returns (fixed, indexed or variable) and life expectancy; (3) Income for life with a guaranteed period certain benefit (also known as Life with Period Certain). Provides a guaranteed payout for life with a period certain phase. If the contract holder dies during the Period Certain phase, a beneficiary will receive payments for the remainder of the period; (4) Joint and survivor annuity – a beneficiary continues to receive payouts for the rest of his or her life after the contract holder dies. This is a popular option for married couples.
Index: In this context, Index refers to the level of a particular stock market, based on the combined values of the stocks in that market that meet certain criteria (such as a minimum size or ranking). The percentage change in the level of the Index between specified dates determines the rate of return for an indexed annuity. The index most commonly used for this purpose is the Standard & Poor’s (S&P) 500.
Initial Interest Rate: The rate of interest applied to the initial premium paid to purchase a fixed, deferred annuity. The length of time for which this rate is guaranteed is specified in the annuity contract.
Insurer: The insurer is the company that guarantees payments to the annuity holder. The insurer invests the premium and makes payments into the future. The insurer’s financial strength is critically important when buying an annuity.
Joint Annuitant: A person named in an annuity contract in addition to the owner, who is entitled to receive payments from the annuity. This person’s age and life expectancy are used along with those of the contract owner to calculate the payments on an annuity that provides lifetime payments.
Joint Life Annuity: An annuity that continues to provide payments to a spouse after the death of the contract owner. Beneficiaries receive the remaining payments if both spouses die before the guaranteed payment period ends.
Joint Owner: An individual who co-owns an annuity contract with another person. Both owners have the right to make decisions relating to the contract.
Life Annuity: An annuity that pays a set amount on a regular, periodic basis, from the beginning of the payment period for the duration of the annuitant’s life.
Load: A fee or commission paid by the person who buys an annuity contract. May also apply to other types of investments (including some mutual funds).
Market Value Adjustment (MVA): A fixed annuity that offers a guaranteed rate of return that is usually higher than rates for a standard fixed annuity, but adjusts the value of the annuity if the contract owner withdraws more than the specified free withdrawal amount, or terminates the annuity contract before it matures. If interest rates on US Treasury securities have increased since the annuity was purchased, the market value adjustment is negative, and vice versa.
Multiple Premium Annuity: Similar to a flexible premium annuity, except a multiple premium annuity may require more than one premium payment, whereas the flexible premium annuity provides the option to make more than one premium payment.
Non-Prescribed Annuity: Refers to the way annuity payments are defined for the purpose of taxation in Canada. The ratio of the return of principal portion and the taxable income portion remains constant. Annuity holders in Canada should consult a specialist for more details (see Prescribed Annuity).
Owner-Driven: An annuity whose payment provisions are triggered when the owner dies, reaches a certain age, or is disabled. This is in contrast to a typical annuity where the annuitant (the individual whose age and life expectancy are used to determine the amount of the payments) may or may not be the contract owner.
Participation Rate: Also call the Index Participation Rate, this refers to the portion of the increase in the index that is credited to an equity-indexed annuity’s account value. For example, if the Participation Rate is 90% and the index increases by 10% for the year, the annuity value goes up by 9%. With some annuities, a cap is imposed on this amount.
Payout Period: The period of time during which an annuitant receives payments from an annuity that does not include a guaranteed lifetime benefit.
Period Certain: An annuity that guarantees regular payments for the life of the annuitant, and also has a death benefit if the annuitant dies before the end of a specified period. The remaining payments are made to a designated beneficiary until the end of that period.
Point-to-Point: Refers to one way of calculating the return for an indexed annuity. In this approach, the return on the indexed annuity is simply the percentage change in the index value from the day the annuity is purchased to the day it expires. The alternative method is the Annual Reset.
Premature Withdrawals: The contract owner makes withdrawals from an annuity before reaching the minimum retirement age specified by law, currently 59 ½ years of age. The IRS views premature distributions as coming from the annuity’s investment earnings, so they are taxed. An additional penalty usually applies.
Premium Bonus: An additional amount that is credited by the insurer to an indexed annuity, expressed as a percentage of the upfront premium. A similar bonus, called an interest rate bonus, can be paid to a traditional fixed annuity.
Premium Tax: Refers to a separate tax imposed on premiums for life insurance or an annuity plan by state governments. While not all states impose this tax, those that do may have different regulations for qualified and non-qualified programs.
Prescribed Annuity: Refers to the way annuity payments are defined for the purpose of taxation in Canada. The amount of the taxable income portion of the annuity payments remains the same, allowing for more certain tax planning. Annuity holders in Canada should consult a specialist for more details (see Non-Prescribed Annuity).
Principal: The total amount an annuity contract owner invests in an annuity. This excludes interest and investment returns earned over time.
Private Annuity: An annuity contract entered into by two private parties who agree to exchange a valuable asset upfront for future payments for life. Does not include the guarantee of an insurance company.
Prospectus: A written document that must be provided to the prospective buyer of a variable annuity before the purchase. The prospectus describes the investment goals, past performance, fees and other expenses for investments available for the variable annuity. Not required for fixed or indexed annuities, where the annuity owner is not required to select securities for investment.
Qualified Annuity: An annuity bought with money distributed from a tax-qualified plan, such as a 401(k) Plan, funded with pre-tax income. These annuities receive treatment similar to those tax-favored retirement plans.
Renewal Rate: The new rate of interest credited to an annuity after the current interest-rate period is over, typically on the anniversary of the contract. This rate may be higher or lower than the current rate, depending on economic conditions and the investments used by the insurer.
Single Life Annuity: An annuity in which the periodic payments are made to a single annuity contract owner for life, ending after the owner dies.
Single Premium: An annuity that is funded with a single premium payment and does not accept additional premium deposits after the initial investment. Fixed-rate annuities are commonly structured this way. If the contract owner wishes to invest more money in an annuity at a future date, a separate annuity purchase is required.
Single Premium Deferred Annuity (SPDA): An annuity that is funded with a single premium payment (see single premium annuity), with the payment period commencing some years into the future (the annuity payments are deferred), allowing for investment returns to compound over time. If the contract owner wishes to invest more money in a single premium deferred annuity at a future date, a separate annuity purchase is required.
Single Premium Immediate Annuity (SPIA): An annuity that is funded with a single premium payment (see single premium annuity), with the payment period commencing immediately. If the contract owner wishes to invest more money in a single premium deferred annuity at a future date, a separate annuity purchase is required.
Split-Funded Annuity: An annuity contract in which the initial premium is split into two separate contracts. One portion of the premium is used to fund a fixed deferred annuity with a guaranteed interest rate over a set period of time; the other portion is used to buy an annuity that begins paying income immediately.
Straight Life Annuity: An annuity that pays a specified amount over a set period of time until the death of the annuitant. There is no death benefit when the contract owner dies.
Substandard Health Annuity: A straight-life annuity designed for individuals with serious health problems. The cost of a substandard health annuity depends on the desired payments and the life expectancy of the annuitant. While a shorter life expectancy means the insurer has less time to earn a profit from the annuity, the periodic payouts can be higher to someone with a low life expectancy.
Sub-Account: The portion of a variable annuity allocated to investments in a specific segment of the market, such as a U.S. stock fund, European stock fund, emerging market stock fund, high yield bond fund, etc. The choice of sub-accounts makes up the variable annuity portfolio.
Surrender Charge: A penalty imposed by the insurer if the contract owner terminates the annuity early and withdraws all funds. Surrender charges typically decline every year until they reach 0%, often six to eight years after the contract begins.
Surrender Value: The amount of money the contract owner would receive if the annuity is terminated and the value that has accumulated to date is withdrawn. Surrender charges and any applicable penalties are incorporated to determine the net surrender value.
Tax-Deferral: Refers to the fact that earnings on the premium paid for an annuity are not taxed until they are paid out during the annuity’s payment period.
Tax-Free Transfers: In the context of annuities, this refers to the ability variable annuity owners have to move assets from one type of investment (sub-account) to another without generating a tax liability.
Tax-Sheltered Annuity (TSA): A type of annuity available under Section 403(b) of the US Internal Revenue Code, to employees of public schools, not-for-profit hospitals, charitable organizations, and self-employed ministers.
Temporary Annuity: A type of annuity that terminates after a pre-established period of time (see Annuity Certain).
Term Certain Annuity: An annuity in which payments are provided over a pre-determined period. If the final payment occurs before the annuitant dies, the contract holder simply stops receiving income from the annuity. If the annuitant dies before the term has expired, payments are made to a beneficiary.
Two-Tier Annuity: An annuity that computes the investment return from one of two different interest rates, depending on how long the annuity is held. If held until the maturity date, the interest rate is higher than the rate on a comparable single-tier annuity. However, the annuity is withdrawn before this date, earnings are retroactively adjusted down to a lower rate.
Variable Annuity: An annuity contract that requires the owner to allocate the invested premium among several investments, or sub-accounts. While this type of annuity provides a guaranteed minimum return, its value fluctuates according to the performance of these investments. Annuity owners can change the mix of their investments through a variable annuity without incurring a tax liability.
Withdrawal Charge: A penalty imposed if the annuity contract owner cashes out part of the annuity prematurely. Similar to a Surrender Charge, but applies to partial withdrawals. Withdrawal charges are typically phased out according to a schedule, e.g., 10% before 3 year, 5% after 4 years, 0% after 5 years. These charges may be waived in the event of death or serious illness.