Note:  In this text individuals of both genders are referred to in the masculine sense for simplicity purposes only.

The purpose of this text is to discuss annuities in greater depth than presented in a basic course with special emphasis given to California insurance laws and regulations where applicable.

Annuities per se will be discussed in considerable detail as product knowledge is essential in marketing annuities as with that knowledge there is less chance of unintentional misrepresentation.  This text accentuates laws and regulations; such regulations often are a result of unethical actions.  Therefore, when an act is considered and the action itself is not illegal, professionals always take into consideration whether it is ethical and if it meets the standards of the profession.




The word itself, annuity is derived from the Latin word annus, which means “year,” therefore, at its root; “annuity” connotes an annual payment.  Of course, annuity payments can be paid annually, semiannually, quarterly or monthly.

If payments are to be made for a defined period of time that has no relation to the duration of a particular human life, this is known as an annuity certain.  This is often used in mortgages and bank loans.

Conversely, if the payments are to be made during a specified lifetime, the annuity is known as a life annuity or single-life annuity.  Sometimes it is called a whole-life annuity for the purposes of distinguishing it from a temporary life annuity (where payments are made during a particular period of time contingent on the person being alive to accept the payments).  The temporary annuity expires with the either death of the individual designated or at the end of a certain specified period of time, whichever comes first. 

The term “life” in the title of an annuity means that the annuity payments are based on life contingencies or continues only as long as the person is alive.  Life annuities are, obviously, created by life insurance companies.

Similarity With Life Insurance

There are several similarities between life insurance and annuities, although the primary functions are diametrically opposed, e.g., life insurance creates an estate; annuities liquidate the estate.

Both life insurance and annuities protect against loss of income; life insurance against loss of income from premature death, annuities from losses because of excessive longevity.  Looking at this from an economic standpoint, neither contingency is desirable.

Both are creatures of “pooling.”  Life insurance funds are pooled so that those who make contributions to the pool do so in order for their dependants to be at least partially compensated for the loss.  Those who contribute to an annuity pool do so in order for those who live beyond their life expectancy to not “outlive” their income.

Both life insurance and annuities base their contributions on mortality tables—albeit not the same mortality tables—which show probabilities of death and survival.

With both arrangements, the contributions (premiums) are discounted for the compound interest that the insurance company will earn on those funds.



The annuity concept starts with the fact that human life in unpredictable.  While an individual may have accumulated funds over a period of years which are designated to be used for income when the individual does not or cannot work any longer, and which should be adequate if liquidated over the remaining years of the life of the individual, the problem is estimating the length of the life of the individual. 

If the individual is of good health and expects to live for a goodly number of years, they must plan to spread the accumulated funds over a longer period of time.  Conversely, the person may die prematurely because of a variety of reasons, such as vocation, avocation, violence, auto accidents, etc.  If they die prematurely they would leave the funds to the dependant or estate, funds which the individual could have enjoyed during his lifetime.

If the individual is willing to pool the funds with others that have similar funds and with the same predicament, then the agency managing the funds (insurance company usually) would rely upon the laws of probability and large numbers, and thereby provide each of the participants in the pool with a specified income as long as he/she lives, no matter how long that is.  That way, no one could outlive his investment.  However, there obviously is one factor that must be taken into consideration: each participant must be willing to have some—or in some cases, all—of their principal that has not been liquidated to be used to supplement those who have exhausted their principal because they have lived beyond their life expectancy.

Every annuity payment is comprised of principal and the income of the unliquidated funds.  Every year a larger proportion of the annuity payment is composed of the principal.  If the individual exactly meets the longevity assumptions, then their principal would be completely exhausted with the last payment being made at time of death.  However, if one lives longer than the expected mortality period, their annuity funds will come from those who forfeited their funds by dying before they reached their life expectancy.  This is a fair and equitable arrangement, as no one knows whether they will or will not outlive their life expectancy.




There are several methods of classifying annuities, but for the purposes of this text, annuities can be classified by (a) the number of lives that are covered; (b) the time that payments start; (c) the method of premium payments, and (d) the nature of the obligations of the insurer.

Number of Lives Covered

Simply put, this refers to whether the annuity covers one life, or more than one life.  If it covers more than one life, it would be a joint annuity, or a joint-and-survivor annuity.  A joint annuity provides that income will cease upon the death of the first of the lives involved, a rather uncommon type of annuity.  The joint-and-survivor provides that funds will cease only when the last death among those covered occurs.

When Payments Start

Annuities may be immediate or deferred.  Payments under an immediate annuity start immediately, as the name implies.  If the contract calls for monthly payments, the first payment starts a month after the date of purchase.  Regardless of the annuity payment period, the first payment starts to accrue immediately after purchase.  Immediate annuities are purchased with a single premium and the annuitant receives a promise of income for life or for a specified period of years, whichever is the case.

With a deferred annuity, a period longer than one payment interval must lapse after the purchase date before the first benefit payment is due; usually this is a spread of several years.  It is usually purchased with periodic payments payable over a number of years.  This is the vehicle used by many who want to accumulate a sum of money for retirement.

Method of Premium Payments

Immediate annuities are purchased with a single premium, and deferred annuities are usually purchased on an installment basis, although they can be purchased on a single premium basis also.  In today’s environment, it is difficult for most people to accumulate the purchase price (consideration) for a single premium annuity; therefore the deferred annuity provides an attractive and convenient method of accumulating the necessary funds for pension and old-age income purposes.

Note:  The purchase price for a single premium annuity is actually a “consideration” instead of a “premium.  The term “consideration” is used frequently in California state regulations.  “Consideration” is the proper term for funds and stems from contract law—after all, it is an annuity contract.  Basically, it is something of value—such as an act, forbearance, or a return promise—received by a promisor from a promise.1  A premium is a periodic payment required to keep an insurance policy in effect.  The key words are periodic payment and insurance policy.  The annuity owner can stop paying “contributions” to the insurance company and the annuity will still continue (unless the funds previously collected do not meet a necessary minimum, etc.) but the annuity payments will not be as large as intended.  Technically, an annuity is a contract, and not necessarily a “policy.”  “Premium” connotes a mandatory payment to an insurer of a pre-determined amount, although with variable products, it is true the difference become rather nebulous at times.  In this text, “purchase price,” “investment” in an annuity, and “consideration” may be used interchangeably.  “Contributions” is used when there can be an employer-employee relationship—generally used in qualified retirement plans and for taxation of benefits.

Pure or Refund Annuity

A pure life annuity—also known as a straight life annuity—provides periodic payments (generally monthly) that will continue as long as the annuitant lives and which stops at his death.  Upon his death, the annuity is considered as fully liquidated, regardless of how long it has been since the contract was issued, and further, there is no refund payable to the deceased annuitant’s estate.  Also, there is no guarantee that any particular number of payments will be made.  (This refund feature can apply to either an immediate or a deferred annuity.)

The annuities are flexible and it is possible to have an annuity that stipulates that no part of the price of the annuity will be refunded at death, regardless of when the annuitant dies—even if before the payments commence. 

Conversely, the contract would refund all paid premiums (with or without interest) if the annuitant dies before payments commence.  Obviously, it is necessary to distinguish between the accumulation and the liquidation periods in determining whether the contract is a pure annuity or a refund annuity.

A refund annuity is any type of an annuity that returns part or the entire purchase price of the annuity, and encompasses different methods of refunding the price.  The refund annuity is much more popular than pure annuities for obvious reasons.



This discussion pertains to the various methods by which a principal sum can be liquidated on the basis of life contingencies.  It may be noticed that principles involved apply to the life-income options of life insurance policies when the death benefit funds the lifelong payments.



The “pure” annuity is noted by three characteristics:  (a) only lifetime benefits are offered; (b) there are no refunds; and (c) there are no benefits paid after the death of the annuitant.  The consideration paid for the annuity is fully earned by the insurer when the benefit payments begin.  Payments can be monthly, quarterly, semiannually or annually, however,

F the more frequent the periodic payments, the more costly the annuity in terms of

annual income.


As an example, 12 monthly payments of $100 each with the first payment due one month after the annuity effective date, is more costly than one annual payment of $1,200 that is due one year after the annuity effective date.  The reasons for this difference in cost is the added administrative cost of the insurer in issuing 12 checks instead of one, plus the loss of interest that the insurer suffers by paying throughout the year, plus there is a greater probability that the annuitant will live to receive the payments.  For instance, if the annuitant dies 6 months after the effective date, he will have received $600 during his lifetime if payments are made monthly.  If payments are annual, the annuitant would have received nothing, the consideration would go into the “pool” as explained earlier.

Some annuities are apportionable which means that they will provide for some sort of pro-rata payment covering the period from the date of the last payment to the date of death.  This helps, but it comes with a price as the price of the usual annuity is calculated on the assumption that there will not be any such pro-rata payment.

The pure annuity provides the maximum income per dollar of outlay and is, therefore, the most suitable for persons with only a limited amount of capital.


As an example, a contribution of $1,000 will provide a monthly income of between $7 and $10 for males ($6 and $9 for females) with a straight life annuity to age 65.  Therefore, if payments are guaranteed for 10 years, regardless if he lives or dies, the monthly income will be reduced approximately $.50 for each $1,000 increment.  (Note:  the income would be different if it were a single-premium policy, primarily because of insurer’s expenses.)  If the contribution was $100,000, the difference in monthly income would be $50 which could be significant to a retired person.  Taking this one step further, at age 70 the difference in monthly income from $100,000 would be $100, and at age 75, the difference would be $175.  This would be too significant to ignore and is most important when discussing annuities with seniors.

However, at younger ages where there is a higher probability of survival, the difference in income between a refund feature and annuity without such a feature is very small. Even at age 55, using the same calculations and assumptions, the annuitant can obtain a 10-year guarantee at a reduction in monthly income of less than $.50.  Therefore,

F males under 60 and females under 65 should not purchase a pure annuity unless a limited amount of capital makes it imperative.



Because of the objections of so many people about placing a rather substantial sum or money into an annuity that provides for no (or very little) return in case of early death, insurers found that it was necessary to add a refund feature, such feature taking two forms: promise to provide a certain stipulated number of annuity payments regardless if the annuitant lives or dies, or a promise to refund all (or at least a portion) of the purchase price in case of the early death of the annuitant.  These take two forms:  Life Annuity Certain and Installment Refund Annuity.

Life Annuity Certain

A life annuity certain may be known as a  life annuity certain and continuous, life annuity with installments certain, life annuity with a period certain guarantee or life annuity with minimum guaranteed return.  Basically, a stipulated number of monthly annuity payments will be made if the annuitant lives or dies, and payments will continue for the remainder of the annuitant’s life if he lives beyond the guaranteed period.  Guarantee periods can be 5, 10, 15, 20 and some even offer 25 years, but the range of choices vary by insurer.

This type of annuity actually consists of two types of annuities, an annuity certain and a pure deferred life annuity.  The annuity certain provides a period of guaranteed payments, whether the annuitant is alive or dead.  The deferred life annuity becomes effective at the end of the guaranteed payment period and provides benefits only if the annuitant is alive at the end of the term of the annuity certain.  Therefore, benefits are deferred and the annuitant must be alive to receive them.  If the annuitant does not survive the guaranteed payment period, no payments are made under the deferred life annuity, and there are no refunds.  If the annuitant does survive the annuity certain term, the deferred life annuity provides benefits for the remainder of the annuitant’s life.

As an example, assume Robert purchases a life annuity with a 10-year certain guarantee.  At the death of Robert, he had collected monthly benefits for 8 years, with an additional 2 years of monthly benefits being paid to the contingent beneficiary.

A period certain annuity is always more expensive (per dollar of income) than a straight life annuity because it is not based entirely on life contingencies.  Since some of the payments are a “certainty,” the only factor that reduces the price is the compound interest earned on the unliquidated portion of the purchase price.  Therefore, the longer the period that payments are guaranteed, the more costly the refund annuity.  Also, since this type of annuity is not based upon life contingencies, the cost of an annuity certain does not depend on the age of the annuitant, but relates directly to the length of the term. 

Regardless of age, the longer the guaranteed payment period, the less expensive the deferred life annuity will be since the higher the age at which the deferred life annuity starts, the smaller the probability that the annuitant will survive to that age, i.e., the larger the number of guaranteed payments, the smaller the part of the purchase price that is allocated to the deferred life annuity.

Installment Refund Annuity

The installment refund annuity promises to return all or a portion of the purchase price if the annuitant dies before receiving monthly payments equal to the consideration paid by the annuity owner, and the payments will continue to a contingent beneficiary/beneficiaries until the full consideration has been recovered.

The present rates of some insurers show that a $100,000 consideration will provide a monthly income for life of somewhere between $650 and $950 on the installment refund contract to a male annuitant age 65 at time of purchase (yes, there is that much disparity in the marketplace).  Therefore, if the annuitant dies after receiving 100 payments, for example, (which will be between $65,000 and $95,000) the payments will be continued to a contingent beneficiary until and additional amount ($35,000 - $5,000) is paid.  However, if he dies after 13 years, there will be no further payments as the entire consideration will have been recovered.  Still, the payments to the annuitant will continue as long as he is alive, even if the consideration may have been recovered in full.

Cash Refund Annuity

The cash refund annuity promises to pay to the estate of the annuitant or a contingent beneficiary at the time of the death of the annuitant, a lump sum equal to the difference between the consideration and the sum of the monthly payments.  The only difference between the cash refund and the installment refund annuity is that the cash refund provides for a lump sum payment.  This would mean the cash refund is more expensive because the insurance company would lose the interest it would have earned if it had been liquidating the remaining part of the consideration on an installment basis.

In case one questions how the insurer can afford to return the annuitant’s consideration whether he lives or dies, and still is able to continue payments to annuitants who have already recovered their investment—The answer is “Welcome to the wonderful world of compound interest!”  It should be pointed out that the insurer does not promise to pay out benefits that are equal to the consideration plus interest.  The interest earnings on this type of annuity on the portion of the consideration paid by all annuitants receiving benefits provide the funds for payment in excess of any particular annuitant’s consideration.

Fifty Percent Refund Annuity

A fifty percent refund annuity is simply an annuity that guarantees a minimum return of one-half of the purchase price (consideration).  If the annuitant dies before receiving benefits that are equal to half of the consideration, monthly installments are continued until the combined payments to both the annuitant and a contingency beneficiary equal half of the consideration.  The beneficiary may receive this amount in a lump sum.

The guarantee of this type of policy is less than that that under the 100% refund annuity, so it costs less.  On the other hand, the income per dollar of purchase price is lower.

A similar type of annuity returns 50% of the consideration in the form of a death benefit regardless of the number of payments received prior to the death of the annuitant.  Half the consideration is used by the insurer to provide a straight life annuity, and remaining half is kept on deposit by the insurer.  The earnings on the half kept by the insurer are used to supplement the annuity benefits provided by the other half of the consideration.  When the annuitant dies, the deposit is returned to the estate of the annuitant, or to a designated beneficiary, in the form of a death benefit.

Modified Cash Refund Annuity

Another type of refund annuity used in contributory pension plans, is the modified cash refund annuity.  If the employee dies before receiving retirement benefits that are equal to the accumulated value of his contributions, with or without interest, the difference between the employee’s benefits and contributions will be refunded in a lump sum to the estate of the employee, or a designated beneficiary.  This refund is based on the contribution of the employee and not on the part of the total cost of the annuity paid by the employer.



Sixteen insurers who market annuities were surveyed in January 2006, and while the quotes varied somewhat, an average of all companies were used for this survey, all licensed in California.  The deposit of $1,000 was used.


                                                                                        Male Age                                              Female Age                         
                                                                                60           65           70           75           60           65           70           75

Single Lifetime Income
 with no payments to a beneficiary.                                $6           $6           $7           $9           $6           $6           $7           $8

Single Lifetime up to 5 yrs guaranteed to
beneficiary                                                            $6           $6           $7           $8           $6           $6           $7           $8

Single Lifetime with up to 10 years
guaranteed to beneficiary                                  $6           $6           $7           $8           $6           $6           $7           $7

Single Lifetime with up to 15 years
guaranteed to beneficiary                                  $6           $6           $6           $7           $6           $6           $6           $7

Single Lifetime with up to 20 years
guaranteed to beneficiary                                  $6           $6           $6           $6           $6           $6           $6           $6


                                                                                                                                                                (Continued next page)


Guaranteed income 5 year period certain      $17         $17         $17         $17         $17         $17         $17         $17

Guaranteed income 10 yr. period certain       $10         $10         $9           $9           $9           $9           $9           $9

Guaranteed income 15 yr. period certain       $7           $7           $7           $7           $7           $7           $7           $7

Guaranteed income 20 yr. period certain       $6           $6           $6           $6           $6           $6           $6           $6

Guaranteed income 25 year period certain    $6           $5           $5           $5           $5           $5           $5           $5


With the computer power available to insurers, it is possible to design annuity contracts with any length of period certain or with a refund guarantee for any portion, from none to the entire purchase price.  However, insurers most likely will offer only a few options regarding period certain choices and refund.  The principal reason that insurers do not offer more choices is the cost of getting approval from regulatory bodies for each of the variances.



The preceding discussion of immediate annuities dwelled principally on the liquidation phases of the annuities, but with deferred annuities, one must distinguish between the accumulation period and the liquidation period.  With immediate annuities, the assumption is the funds were needed to provide the range of income payments were on hand.

With deferred annuities there must always be an accumulation period during which the funds are with the insurance company so that they can provided the promised benefits at a specific future date.  These funds may be accumulated from a lump sum consideration to which compound interest is added each year as the consideration grows; or it may be accumulated through a set of periodic premiums which can range anywhere between a set of established level premiums to a flexible considerations where the timing and amount of each payment is entirely at the discretion of the purchaser of the annuity.

Obviously, with flexible premium plans it is not possible to forecast the amount that will be available to be paid as benefits during the liquidation period, so they specify the amount of the benefit per $1,000 of accumulated funds (fund balance) when the annuity starts the accumulation phase.  One way to look at this is that the fund would be just a device to accumulate funds similar to a defined-contribution pension plan prior to retirement.

Regardless of how the contributions/considerations are made, the question arises as to what the company’s obligation is if the purchaser dies prior to the date the income commences.  The contract could provide no refund of premiums if the annuitant dies before receiving any payments—which would make it a “pure” annuity—not very appealing to most.  However, with private pension plans, contributions of the employer are usually applied to the purchase of pure deferred annuities, thus if the employee terminates employment, the employer recovers his (the employer’s) contributions plus any interest that has accrued.  If the employee dies, then the employer’s contributions stay with the insurer stay in order to provide benefits to those employees who stay with the employer until they retire.  This is a less expensive method of funding retirement plans than one that returns contribution at the death of the employee, which is a good thing as the employer can provide larger retirement benefits than they could otherwise afford.

Individually, deferred annuities sold to individuals will return all payments, with or without interest, in the event of the annuitant’s death before annuity payments are made.  Usually the choice is the return of gross premium without interest, or the cash value—whichever is larger.  Therefore such an annuity contract is a type of refund annuity.

Liquidation Period

In respect to the liquidation of deferred annuities, the earlier discussion about immediate annuities covers liquidation of deferred annuities also.  When the annuitant is ready to start receiving income from the annuity (often called “entering on to the annuity”), choices are available, which could include a straight life annuity, a life annuity with guaranteed installments, an installment refund annuity, or a cash refund annuity.  They may be provided the choice of a cash settlement instead of receiving installment payments.  It is possible for annuitant to choose a straight life annuity, for example, for the liquidation phase of a refund type of annuity, however most prefer the refund basis during both the accumulation and liquidation phase.

A form of deferred annuity that had fixed level premiums was popular several years ago, known as a retirement annuity and it provided several options so that the annuity could be adjusted during the deferral period according to the individual’s circumstances.  These were rather heavy front-end loaded, and with the introduction of lower cost and more flexible annuities now available, this annuity has almost disappeared.



Please note that the following two sections describe in general the contract construction and provisions of the contract.  The Insurance regulations for the state of California specifically addresses many of these points, particularly regarding liquidation and these regulations will be discussed in detail following these sections.  You may also note that since the regulations address various types of annuities, these discussions will combine all of the various forms for regulatory discussions.  If there is any conflict between these general discussions and the Insurance regulations, the regulations will always prevail.

Premiums for an annuity contract can be expressed in units of $100 annually, or in terms of the annual premium that needed to provide a life income of $10 a month at the particular age.  When expressed in $100 units, the premium will be an even amount which will vary by age at issue and age when payments start.  The $10 a month annuity will have a fixed even amount and the premium will vary.

As an illustration, using the 1983 annuity mortality table (the principal table in use today) and with an average premium rates, for each $10 of monthly life income to be paid to a male annuitant at age 65 guaranteed for ten years, $1200 would have to be accumulated by age 65, regardless of when the annuity was purchased.  The younger the annuitant when the annuity was purchased, the less consideration he would have to pay.

In order to accumulate the $1200 which is the amount needed to provide $100 a month at age 65, a male age 25 would make a consideration payment of around $110 a month, at age 45 the consideration would be approximately $435, and at age 55, it would be about $1200 a year for 10 years. 

The level premiums/considerations are often called “deposits” and are accumulated at a rate of compound interest which is equal to or greater than the specified long-term rate guaranteed in the contract—generally between 3% and 5% or as specified by state regulations.  Some deferred annuity contracts may have a short-term (2-3 or 5 years) interest rate guarantee that is competitive with current investment yields and higher than the guaranteed long-term rate.  These short-term interest rate guarantees are frequently combined with a bail-out provision which allows the contract to be terminated without a surrender charge if the interest rate that is actually being credited falls below a specified rate—often 2 percent. 

It should be noted that this bail-out provision is really not attractive, although on its face it may seem to be, because competitors will probably not be able to pay higher rates if and when the release is activated, and besides, a cash-out will be subject to income taxes and possibly a ten percent penalty tax. (as discussed later).

Basically, if the annuitant dies before age 65 (or the maturity date) the insurer will return either the accumulated gross premiums without interest or the cash value, whichever is larger.  The cash value is the gross premiums increased at a guaranteed interest rate after subtracting an expense charge.   After 10 years, the cash value exceeds the value of the premiums paid (less interest) and this is, in effect, a death benefit.  Note the “crossing the line” between life insurance and annuities as there is an insurance element during the accumulation period where the death benefit exceeds the cash value. 

The annuitant may withdraw the full cash value at any time during the deferral period, and at that point the contract terminates and there is no further obligation of the company under that contract.  If, as with some contracts, the annuitant has borrowed against the contract, this would not create a termination.

Choices at Liquidation

When the annuity matures, the annuitant has the option of electing to have the accumulated sum applied under any annuity form offered by the company—even though the premium deposits/consideration was based upon the assumption that income would be provided under a life annuity with 120 guaranteed installments, or, as indicated previously, the annuitant can simply take the cash. 

To be considered is the fact that the cash option creates adverse selection against the insurer.  A person in poor health may want to take the cash option as they may not live long enough to take the installment distribution.  Therefore, the insurance company does not have the ability to receive interest on the undistributed installments during the liquidation period.  Some insurers have a retroactive reduction in the investment earning rate as applied to accumulations under a deferred annuity, which can be substantial.  Such a “penalty” also applies to annuity contract exchanges.

Most annuities allow the annuitant to have the benefit payments start at an earlier date, which is really just an option to convert the cash value to an immediate annuity.  There is usually no age limit below which the benefits cannot start, but obviously the periodic income payments cannot equal or exceed a stipulated minimum amount.

There is an upper age limit—ages 70 to 80, depending upon the contract—beyond which payments must be made.  The life income payable at any particular age, even if the maturity date is advanced or set back, is still the same amount that would have been provided had the newly selected maturity date been the one that was originally selected and funded and the actual amount accumulated.


Simply put, a surrender charge  is a fee charged to a policyholder when an annuity (or life insurance policy) is surrendered for its cash value.  The fee reflects insurance company expenses incurred by placing the policy on its books, and subsequent administrative expenses.  Technically, they are contingent deferred sales charges imposed by the life insurance company that reduces the amount paid to the owner of an annuity on a complete or partial surrender of the contract.  Usually these charges are imposed only for some initial period after the contract is purchased, and then they decline to zero after 5 or 10 years. 

The amount of the charge varies and is determined using different methods.  The typical method, or at least the commonly used, is a percentage of the cash value (equal to the premiums paid plus earnings).  The first year the surrender charge could be, for instance, 7%, and then declining each year by 1% to 1% in the 7th year. 

Another method imposes the surrender charges on premiums and not on earnings.  A new surrender charge period applies to each premium, with the oldest premiums being withdrawn first. 

Many deferred annuity contracts provide for waiver of surrender charges if certain contingencies occur, such as admittance to a nursing home,  Also, a partial surrender (the withdrawal of some amount less than the entire cash value of the annuity) may or may not have a surrender charge and many contracts allow annual withdrawals of a certain amount or percentage of the cash value without a surrender charge.

The reason for surrender charges is that when an insurer issues a deferred annuity, usually it invests all of the premium paid for the contract without taking any of the premium for expenses (such as commissions) that it incurs.  So, if a person invested $10,000 in an annuity with Acme Insurance, Acme will invest the entire $10,000 in the investment options selected by the individual, even though Acme pays its agents 6% commission ($600) and has other issue expenses and administrative costs the first year.  The insurance company expects to recover its sales expenses from asset-based fees over a period of years.  Therefore, if the contract is surrendered prematurely, the surrender charge compensates the insurer for the loss of that fee income.

Stopping or Altering Annuity Payments After They Start

On occasion annuity payments can be stopped or altered after they start, even though as a general rule, annuity payments are treated by both the annuities and the insurers as unalterable after payments have started, with the exception of term certain annuity, (an annuity under which payments will continue for a specified period of time, usually between 5 and 30 years, regardless if the annuitant survives).

Recently, annuity payments options have been offered allowing the annuity owner to modify the amount or duration of the payments after they have begun.  These options have been developed to provide services to those who have a stream of payments that will continue as long as they live, and at the same time, maintaining some liquidity with their annuity assets.

Systematic Withdrawals

A systematic withdrawal program is simply a scheduled series of partial surrenders or withdrawals from a deferred annuity prior to the maturity of the annuity.  Many annuities allow certain amounts to be withdrawn annually without surrender charges being assessed.  As opposed to annuity income payments, systematic withdrawals can continue just as long as there is a cash value.  The withdrawal program does not guarantee that payments will continue for any specified period of time.

Since the owner has the ability to stop, either temporarily or permanently, withdrawals, a great deal of flexibility is offered with a systematic withdrawal program.  This means that the deferred annuity has higher liquidity with this program than the typical annuity income option.  This can be of particular interest to retired people who may have unexpected expenses for an uncertain duration.  Temporary nursing home costs come to mind.

It is important to note that the federal income tax treatment of annuity income payments and systematic withdrawals differ rather substantially, which should be taken into consideration before using a systematic withdrawal program.

Deferred Annuity Death Benefit

Deferred annuities provide for a death benefit prior to the anniversary starting date, with differences between contracts as to amount and under what circumstances it will be paid.

Typically, the deferred annuity contracts provide for a death benefit if the annuitant or the owner dies before the maturity date of the annuity.  Interestingly, until 1985 only the annuitant was covered with the death benefit, but then the federal tax law required the distribution within five years of a contract’s entire cash value if the “holder” dies before the maturity date, so now the owner is also covered.  Recently, some deferred annuities have provided that a death benefit is payable only if the owner dies and the contract provides for a new annuitant to replace the deceased annuitant.  If the annuity is owned by a trust, the contract will still provide that the death benefit will be paid upon the death of the annuitant because of the requirements of the federal tax law.

The amount of the death benefit payable under a deferred fixed annuity contract is usually the accumulated value of the contract, reduced (in some cases) by any applicable surrender charges.  Normally, the amount of the death benefit may be paid either in a lump sum or as annuity income payments.

In any event, in the state of California the death benefit must be at least equal to the surrender value. 


Annuities, of all kinds, both variable and fixed, are primarily marketed as long-term retirement plans with various features that help the individual in accumulating assets and a wide range of methods of disbursement of assets in retirement.  The marketing in respect to the accumulation stage, has—and always will be—on the tax advantages that annuities offer plus the protection of the death benefit to the beneficiary.  On the disbursement part, the various ways that income can be taken in retirement are always stressed, particularly payments that are guaranteed to last for life.

The tax deferral on annuity earnings is an important feature for investors that are looking for long-term retirement plans as the deferral of tax can make substantial difference in the amount that can be accumulated.  With variable annuities (as discussed later in detail), the ability to make tax-free transfers allows the annuity owners to make decisions on their investments based on strategy that they feel will serve their best interest.

Since income payments from an annuity are taxed as ordinary income to the taxpayer, this is interpreted by some as a disadvantage.  Such a “disadvantage” is more than offset by the fact that annuities enjoy tax deferral if the annuity is held for a period of time.  Plus, many persons will be in a lower tax bracket when they retire, so the disbursement that may be taxed at that time will be taxed at a much lower rate.  And, as discussed later, part of each payment is considered as a tax-free return of principal until the entire investment has been recovered—the vehicle to accomplish this is called the ”exclusion ratio” and described in more detail in this text.

On top of that, not all of the gains from other investments, such as mutual funds, are entitled to long-term capital gains treatment.  Mutual funds must distribute all dividends, short-term gains and long-term capital gains realized by the fund from its investments, usually by annual distribution.  Short-term gains and certain dividends are taxed at ordinary income tax rates.

Sales of Variable Annuities

The sales of Variable Annuities grew rapidly in the 1990s and the assets grew more than four times over the 10-year period ending in 2000.  Assets increased from $176 in 1991 to over $1 trillion in the first quarter of 2000.  From 2000 through 2004, variable annuity assets grew to $1.1 trillion.  The rapid growth of the equities market during this time contributed to this growth, along with retirement concerns.



(Source of statistics for graphs is LIMRA Int’l and result of 2001 Survey by the Gallup organization)


Sales of Fixed Annuities

Fixed annuities dropped to a low in 1998 and then increased, with the heaviest sales in 2002.  Net assets have remained rather stable (and stagnant, one might say) until 2002, when they picked up.  The decrease from 1998 - 2002 is attributed to aggressive marketing as a safe alternative to individuals who had suffered losses in the bear market during those years.  They decreased by some 13.5% in 2003 as a result of a rebounding equity market and very low interest rates. 

By assets, fixed annuities make up 32 percent of the total annuity market at the end of 2004.  By contrast, in 1994 fixed annuity assets accounted for over 53 percent of the total.




Marketing of Fixed Annuities

With variable annuities, captive agents have the largest number of sales; with fixed annuities, independent agents and banks provided 41 percent and 33 percent of all sales in 2004, respectively. 




Equity-indexed Annuities Marketing

An Equity-indexed annuity (EIA), is a fixed annuity that offers the potential of investing in the equity markets—with a guaranteed rate of return.  From 1994, the EIA market increased from .5% of the fixed annuity sales, to 27% in 2004.  EIAs represent more than 31% of the deferred fixed annuities in 2004.  Sales increase was 74% in 2002, 22% in 2003 and 69% in 2004, with total 2004 sales of $24.3 billion.



In November 2000, the Gallup Organization surveyed 1,005 present owners of non-qualified annuity contracts written by 46 life insurance companies, for the Committee of Annuity Insurers.

Typical Owner

The typical owner of a non-qualified annuity is at least a high-school graduate with a moderate annual household income.  The average age is 65 and owners are more likely to be retired than employed, more likely to own a variable annuity and they are about 50/50 male-female.


Average age of non-qualified annuity contracts is 65, with one-third (35%) age 72 or older.  About one-fifth of the owners are under age 54 (20%), between age 54 and 63, 23%, and between age 64 and 71 there are 22%.




Marital Status of Annuity Owners

63% of non-qualified annuity owners are married, 20% are widowed, 10% never married

Marital Status




Owners of non-qualified annuities have a variety of educational background.  More than half (56%) are not college graduates, one in five (20%) have had post-graduate work or degrees.

Employment Status

More than half (56%) are retired, 31% are employed full-time and 7% are employed part-time.




Intended Use of Annuity Savings by Age

Owners of non-qualified annuities were asked to name the major use for which they intend to spend their annuity savings.  No surprise, but 81% said that they intend to use the savings for retirement income.  Retirement is mentioned as a primary use for annuity savings by those who are under 54 (82%).  Twelve percent (12%) say that they plan to use their annuity savings to live on or be financially independent.  Those age 64 or older say they intend to use their savings as an emergency fund to take care of catastrophic illness or nursing home care.

Intended Use of Annuity



Sources of Retirement Income

When the current sources of retirement income from retired annuity owners are compared with the expected retirement income of those who are not retired, there are several differences.  Basically, those who are retired rely more upon Social Security for their income, but those who are not retired say that they expect to pay more of their own money that they have personally saved for retirement.  Over half of non-retirees expect that personal savings not related to any retirement plan through an employer will be a major source of income, and only 1/3 of retired owners say this is currently a major source of income.

Almost half of non-retirees (48%) believe that the money they have put into a retirement plan at work, such as a 401(k) plan, will be a major source of retirement income.  Another difference is that whose who are retired rely more on Social Security for their retirement income but only 26% of non-retired owners expect Social Security to be a major retirement income source.




62% of non-qualified annuity contracts have annual household incomes under $75,000, 41% have household income below $50,000, and 26% have household income of less than $40,000.  Past and recent surveys have all shown that owners of non-qualified annuities have total household income between $20,000 and $74.999.


Sources of Information Regarding Non-qualified Annuities

Owners of non-qualified annuities reported that they had talked to a wide variety of people when making a decision to buy an annuity.  Most often mentioned were financial planners (43%), stockbrokers (17%), insurance agents (12%) and bankers (6%).

Owners of variable annuities are more likely to talk to a financial planner (50%) than are owners of fixed annuities (29%), but owners of fixed annuities are more likely to talk to an insurance agent (18%) or a banker (10%) than are owners of variable annuities.  The older the owner, the less likely that they have talked to a financial planner—58% of those under age 54, compared to 36% of those age 72 or older.



Perhaps the most telling of all of the surveys was where the respondents were asked the importance of various reasons for buying an annuity.  The most important reason was “Earnings would not be taxed until the funds were used” —89% responded that this was a “very important” reason.  This was followed in order of importance: “Was a safe purchase,” “Had a good rate of return,” “Wanted a long-term savings plan,” “Income guaranteed for life,” “Easy way to save,” “Emergency fund,” “Choices in ways of getting to the money,” and “Provides money in case owner or spouse needs to enter a nursing home.” 

When asked whether they agreed with various statements about annuities, 91% agreed with the statement, “Annuities are an effective way to save for retirement,” and “Annuities are a good way to ensure their surviving spouse has a continuing income,” followed by “Keeping the tax advantage of annuities is a good way to encouraging long-term savings” (90%).

Taxation benefits obviously rates very high in “reasons to purchase annuities,” and in the same vein, seventy-four percent (74%) of the owners of non-qualified annuities believe that the government should give tax incentives to encourage people to save.  Remember that this survey was conducted the latter part of 2000 and previous surveys had been conducted over several years earlier, but the “government” has in recent years encouraged individuals to save as evident with the Roth IRA program and the relatively-new “Health Savings Account.”



1.  Life insurance creates an estate, annuities

      A.  destroys an estate.

      B.  have no effect on an estate in any fashion.    

      C.  creates a different kind of estate.

      D.  liquidates the estates.


2.  Every annuity is comprised of

      A.  the principal and the income of the unliquidated funds.

      B.  level and fluctuating premiums.

      C.  deferred cash values.

      D.  immediate funds and future funds.


3.  Payments from an immediate annuity starts

      A.  a month after the date of purchase if the contract calls for monthly payments.

      B.  within one year of the starting date of the annuity regardless of the payment period.

      C.  upon retirement or age 70 ½, whichever comes first.

      D.  at death of the annuitant.


4.  An annuity that provides periodic payments that will continue as long as the annuitant is alive, is

      A.  an immediate annuity with refund

      B.  an annuity that returns part of all of the purchase price of the annuity.

      C.  a variable annuity.

      D.  pure, or straight life, annuity.


5.  The cash refund annuity promises to pay to the estate of the annuitant or a contingent beneficiary, at the time of the death of the annuitant

      A.  a specified number of installment payments.

      B.  half of the benefits to the surviving spouse.

      C.  a lump sum equal to the difference between the consideration and the sum of the monthly


      D.  a return of all of the premiums paid less interest accrued, on an annual basis.


6.  When a policyholder turns in his annuity before the expiration date of the contact, a surrender fee is charged because

      A.  it is the sole source of funds for renewal commissions.

      B.  it the only way the insurance company can make a profit.

      C.  it reflects the expenses incurred by the insurer by placing the policy on its books and on-

            going administrative expenses.

      D.  surrender fees are submitted by the insurer to the state insurance department as taxes.


7.  The tax deferral on annuity earnings

      A.  no longer exists due to ERISA regulations.

      B.  is important for long-term retirement as deferral of tax can make a substantial difference

            in the income that can become accumulated.

      C.  ceases at the earlier of (1) 15 years or  (2) the annuitant turns age 70 ½.

      D.  is so small it has little effect on the overall amount to be distributed.


8.  Variable annuity sales and net assets have grown in recent years because

      A.  the bond market has crashed.

      B.  investments in gold and silver creates fluctuations in mutual fund subaccounts.

      C.  of the growth of the equities market, plus retirement concerns.

      D.  commissions on variable annuity have increased dramatically.


9.  Recent surveys of annuities have shown

      A.  a demonstrable shift from fixed annuities to variable annuities.

      B.  a demonstrable shift from variable annuities to fixed annuities.

      C.  there has been no movement in the annuity markets.

      D.  richer and older persons are more likely to own fixed annuities.


10.  When asked, during a survey, the most important reason for purchasing an annuity, the response was

      A.  the price of annuities has continued to drop.

      B.  the slow recovery of the stock market.

      C.  the decrease in the value of the dollar.

      D.  earnings would not be taxed until the funds were used.



1D     2A     3A     4D     5C     6C     7B     8C     9A     10D