What is the definition of an Indexed Annuity?
The word annuity has its origins in a Latin term that means annual. Today, an indexed annuity is an investment product sold by insurance companies. Indexed annuities can be purchased through a series of contributions or in one lump sum. The money put into the fixed indexed annuity contract is allowed to grow for a period of time.
Then, at a future date, the contract becomes a fixed index annuity income through periodic payments over a specified period of time or for a lifetime. The interest or growth in a fixed variable annuity is not taxed unit the fixed indexed annuity is actually paid and received by the owner.
Fixed Indexed Annuities:
Generally, life Insurance creates an estate for a person in case he or she dies too soon. Fixed indexed annuities, on the other hand, protects accumulated assets when a person lives too long. Insurance companies offer a type of policy called a commercial fixed indexed annuities. Typically the policy owner contributes to fixed annuity. The money grows for a period of time. The policy is later a fixed index annuity and the accumulated funds are paid out through a series of payments either over a specific period of time or the life of the individual or lives of a couple.
Parties Involved in a fixed variable annuity and what they do
1. Insurance company:
Issues the variable annuity.
2. Policy Owner:
Contributes funds to the indexed annuity. Policy owners, have many rights including ending fixed annuities, giving it to another person, withdrawing the fixed index annuity funds from it, and changing the annuitant or beneficiary.
3. Annuitant Definition:
Determines the payments during fixed variable annuities. Fixed index annuities are either annuitant driven or owner driven. And fixed annuities remain in force unless terminated by the owner, the owner or the annuitant dies.
Receives any payable on the death of the policy owner or the annuitant. One person may be the policy owner, annuitant, and the beneficiary. These roles can also be held by different people or entities.
Definition for Types of Variable Annuity
• Method of payment:
Single premium variable annuities can be purchased with a single lump-sum of cash. Fixed indexed annuities may be purchased with installment payments over time. The payments can be a fixed dollar amount or with flexible payments.
• Fixed index annuity payment start dates:
Fixed annuities payments typically begin at some time in the future. An immediate fixed annuity is purchased with a single premium with variable annuity payments beginning one payment period, such as monthly or annually, later.
• Investment options:
Funds invested by the policy owner are allowed to grow before the policy is made as an indexed annuity or liquidated.
Definition of Types of the underlying investment vehicles include:
• Fixed and indexed annuities:
With fixed and variable annuities, the issuing insurance company guarantees a minimum interest rate and the company also typically guarantees a minimum fixed and variable annuity benefit. Fixed and indexed annuities offer the principals safety and stable investment returns. The risks involved rest entirely on the insurance company.
• Indexed annuity (EIA):
An EIA is a type of fixed variable annuity that grows and earns interest based on a formula related to a specific stock market index. With an EIA contract, the insurance company offers a return that is based on formula linked to a specific stock market index, such as the Standard and Poor’s 500 Indexed. If the index rises during a specific period, a greater return is credited to the account. If the stock market index does not rise, or declines, the lower minimum rate is credited. EIA principals are guaranteed when the EIA has been under contract for a minimum period of time also known as the penalty period, which can be quite lengthy.
Indexed Annuity Payment Definition
Money from an indexed annuity may be withdrawn or received in any of the following ways:
• Lump-sum withdrawal:
When a policy owner withdraws all of the funds in a single-lump sum, the fixed and variable annuities ends and is considered a surrender of the policy. Depending on the policy and the time the policy has been in force, the insurance company may impose surrender charges based on percentage of the policy.
• Partial withdrawal:
With many fixed index annuity policies, the owner may withdraw a certain portion of the balance each year usually 10 to 15% without a surrender charge.
• Life-only indexed annuity:
Regular payments are made as long as the annuitant lives. Fixed variable annuity payments cease and refunds aren’t made even if the initial investment has not been recovered.
• Life with term certain:
Fixed variable annuities payments are made for a specified number of years or for the life of the annuitant. Even if the annuitant dies before the specified term passes, indexed annuity payments continue to the beneficiary until the term ends.
• Joint and survivor:
Regular payments are made over the lives of two people. When one dies, variable annuity payments or portions continue to the survivor.
• Refund options:
Regular payments are made over the annuitant’s life, but if the annuitant dies before the policy owners investment has been recovered the beneficiary receives a refund in either a lump-sum payment or continued payments.
• Specified period:
Regular payments are made for a selected number of years. If the annuitant dies before the period expires, payments continue to a beneficiary for the remaining term.
• Specified amount:
As long as money remains in the account, set payments are paid out regularly.
Definition of Taxes on Annuity Payments
How payments from an annuity may be taxed varies, depending on the life cycle of the annuity. Based on federal law, generally the following rules may apply:
• Before Annuity:
Any funds withdrawn from an annuity contract prior to annuity (before payments begin) are considered to be from interest or other growth. These earnings are taxable just like ordinary income. If the annuity owner is under age 59 at the time of withdrawal, the earnings are also subject to a 10% IRS penalty. If earnings are completely withdrawn and the payments are made from the owner’s initial investment, the withdrawal is treated as recovery of capital and tax free. Changes to the fixed index annuity contract, including loans, collateral assignments, and changes in ownership may be taxed.
• After Annuity:
fixed indexed annuity payments are treated a part earnings and part capital return. The earnings portion is taxable. Once the owner has completely recovered his or her investment, all remaining payments are fully taxable as income.
• Estate taxes:
Amounts paid to a beneficiary after an owner’s death are included in the owners gross estate. If the owner of a life-only fixed indexed annuity contract dies, no payments are due and nothing is included in the estate.
Seek Professional Guidance: Fixed indexed annuity is intended to be long-term investment and the contracts can be complex. Do your research and consider all aspects before entering any contract. Seek the advice and counsel of appropriate tax, legal, and other professional advisers.
About Bill Broich
Bill Broich is a well-known annuity expert with over 30 years of experience. He has written hundreds of articles on annuities and other financial topics, and has been a featured commentator on TV, Radio and the Internet. To follow Bill”s profile, click here.