Retirement Annuities: Features and Tax Benefits | Trusted Choice

Retirement Annuities

Complete Guide to Retirement Annuities

(How to retire with income for life)

Jeffrey Green | October 29, 2019
Retirement Annuities

Going broke is a top concern in retirement, according to the American Institute of CPAs  Personal Financial Planning Trends survey.  Retirement annuities have special features and tax benefits, courtesy of Uncle Sam. That’s because they’re intended to provide retirement income.

Contact your independent insurance agent. Ask them if a retirement annuity is right for you.

What Is a Retirement Annuity?

A retirement annuity is an insurance contract that protects you financially from living too long. Retirement annuities provide a guaranteed lifetime income. It’s the flip side of life insurance, which protects beneficiaries from the financial impact of dying too soon.

Retirement annuities that start paying income in a year or less are immediate annuities. Retirement annuities that accumulate money and pay income at a later date are deferred annuities.

Retirement annuities that are part of a pension plan or IRA are traditional qualified annuities. All others are non-qualified.

Owners, Annuitants, and Beneficiaries

An annuity policy is a contract between the insurance company and these folks.

The owner has the sole right to the values and payments in the contract. The owner decides who the annuitant and beneficiaries are. The age and sex of the annuitant are how the insurance company determines the amount of income. The annuitant and owner don't have to be the same. The beneficiary receives the proceeds at the death of the owner or annuitant.

The insurance company issues the policy and has to honor the promises in it. Guarantees in the policy are only as good as the ability of the insurance company to pay claims.

Why Buy a Retirement Annuity?

The main benefit of an individual retirement annuity is its protection features. Retirement annuities provide a means to create a predictable guaranteed income. Retirement annuities offer tax-deferred growth for different types of investors.

Fixed retirement annuities have guaranteed values and rates of return. Variable retirement annuities have a selection of investments called subaccount funds. These are similar to mutual funds. Variable annuities offer investors some guarantees and market-based returns. Like mutual funds, subaccount funds have investment risk.

How Much Does a Retirement Annuity Cost?

  • Front end sales loads: The front end sales load is deducted from your purchase payment. Most products on the market today don’t have a front end sales load.
  • Surrender penalties: Most retirement annuities charge a fee if you cash in your contract, or withdraw more than 10% of the cash value. Surrender penalties decline to 0 over a period of years, usually not more than 10.
  • Fees & expenses: Variable retirement annuities have mortality and expense fees, investment manager fees, and optional rider fees.
  • Market value adjustments: The insurance company pays a fixed rate of return and absorbs any market risk. If you cash in your contract early, the insurance company loses money if interest rates are rising. The insurance company profits if interest rates are declining. The market value adjustment will be a cost or a bonus depending on interest rates.
  • Rider fees: Optional riders like enhanced death benefits and living benefits have a cost. The fee is usually a percentage of the cash value.

How Do I Get Income from a Retirement Annuity?

The income from a retirement annuity is determined by the account value and the option that you select. The income from variable retirement annuities can go up or down based on the investments selected. The chart below outlines the options. Once an income option is selected, there is no access to account values.

Guaranteed Income Options

During LifetimeAt DeathAdvantagesDisadvantages
Life Pays income for annuitant’s lifeNoneHighest incomeNo refund of unused principle
Life and 10 Years CertainPays income for life. Not less than 10 yearsBalance if death occurs before the end of 10 yearsProtection for beneficiariesLower Income
Life and 20 Years CertainPays income for life. Not less than 20 yearsBalance if death occurs before the end of 20 yearsProtection for beneficiariesLower Income
Life With Cash RefundPays income for life. Payments are at the least specified refund amount.Balance of refund amountProtection for beneficiariesLower Income
Period CertainPays Income for a specified number of years.Balance of paymentsUseful for certain planning purposesOutliving income
Joint & Survivor 100%Pays income for longer of two lives.No further payments at 2nd deathSurviving spouse continues to receive income for life.Lower Income
Guaranteed Lifetime Withdrawal Benefit Single LifePays income for annuitant’s lifeBalance of accountAccess to account values, death benefitIncome taxed as withdrawals
Guaranteed Lifetime Withdrawal Joint LifePays income for lifetimes of annuitant and 2nd lifeBalance of account at 2nd deathAccess to account, death benefitIncome taxed as withdrawals

What Happens to the Money in a Retirement Annuity When You Die?

If you die during the deferral period, your beneficiary will receive the account value. If you die during the distribution period, the income option that you selected determines what the beneficiary receives. Optional riders may enhance the death benefit. 

How Are Retirement Annuities Taxed?

Tax treatment for traditional qualified annuities, Roth-qualified annuities, and non-qualified annuities is different.

The chart below summarizes tax treatment of retirement annuities.

ContributionsAfter tax. UnlimitedPre-tax. Limits for IRAs and qualified plans apply.After-tax. Limits for IRAS and qualified plans apply.
Growth Tax-deferredTax-deferredTax-deferred
Surrender Gain is taxed at ordinary rates.All proceeds taxableTax-free
Annuity Income Partially taxable at ordinary rates100% taxable at ordinary ratesTax-free
Withdrawals Withdrawals are gain first. Gain is taxed at ordinary rates.100% taxable at ordinary ratesTax-free
Loans Loans are considered withdrawals. Gain first is taxed at ordinary ratesIRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years.IRA loans not permitted. Pension plans may have exceptions for home purchase and loans repaid in 5 years.
Death BenefitsGain is taxed at ordinary rates. Proceeds will be taxed as "gain first."Rules for inherited traditional IRAs and qualified plans apply.Rules for inherited Roth IRAs and plans apply.
Sales Proceeds in excess of basis taxed at ordinary rates.N/AN/A
Penalties10% for withdrawals before age 59-1/210% for withdrawals before age 59-1/210% for withdrawals before age 59-1/2. Penalty for withdrawals prior to  end of the 5th year

What Should I Look for in a Retirement Annuity?

The first concern for any type of annuity is the financial condition of the insurance company. The primary rating services that cover insurance companies are A.M. Best, Moody’s, Standard & Poor, and Fitch. Each has differences in their methodologies and rating designations. 

The rating each service assigns reflects their opinion about the insurance company's ability to pay claims. Look for high-quality ratings from at least 2 of the 4. The chart below summarizes the financial strength ratings of the different services.

Highest Ability To
Meet Obligations
Medium Ability To
Meet Obligations
Lowest Ability To
Meet Obligations
A.M. BestA++ to A-B++ to B-C++ to C-
Moody’sAaa to AaA to BaaBa to Caa
FitchAAA to AA-A+ to BBB-BB+ to CC

What Next?

Retirement annuities can be an important part of your retirement plan. While they have many features and benefits, they are not for everyone. Talk to your independent insurance agent. They can help you decide if a retirement annuity is right for you. Article | Reviewed by Neal Lane
Sources © 2020, Consumer Agent Portal, LLC. All rights reserved.

Advisors Guide To Annuities John Olsen

Fundamentals of Investments Wilson & Hopkins

NAIC Buyers guide to deferred annuities

SEC guide to variable annuities



Fitch Ratings Definitions 

Moody’s Moody’s rating scale and definition

S&P Global Understanding Ratings

A.M. Best Why An A.M. Best Financial Rating Is Important

The American College of Trust and Estate Counsel State Survey of Asset Protection Techniques

© 2020, Consumer Agent Portal, LLC. All rights reserved.

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