Annuities originated from the life income settlement option offered by a life insurance policy. Annuities are insurance products, but they are not designed to provide protection in the event of premature death. An annuity protects against living too long and outliving one's financial resources. The payments from an annuity are guaranteed for a fixed period, commonly for life, in which case the annuitant cannot outlive the stream of monthly payments. Annuities are often used to accumulate funds for retirement. As with life insurance, premiums paid are not tax-deductible, but grow tax-deferred until withdrawn.

Due to the tax-deferred growth and unlimited contribution amounts, annuities are popular with people in high tax brackets. Annuities may be purchased with a lump sum investment (single premium annuity) or with periodic payments. A single premium annuity may also be an immediate annuity, if the owner elects to begin receiving payments immediately. It’s more common to purchase an annuity over time with periodic payments and begin receiving payments at some future date, which is a flexible premium deferred annuity.

The accumulation stage is the period when the owner is investing money into the contract. During the accumulation stage, the cash value in the annuity is invested in shares of open-end investment companies or UITs called accumulation units. During the accumulation stage, the terms of the contract are quite flexible. Unlike life insurance, there is no required premium with an annuity. The owner can invest any amount at any interval. The owner may withdraw funds and may also terminate the contract during the accumulation stage.

A withdrawal during the accumulation stage is a taxable event. The owner of the annuity contract has an ordinary income tax liability on any withdrawal from an annuity in excess of his/her cost basis. Any taxable withdrawal is also subject to a 10% penalty if the owner is under age 59 ½. The 10% penalty only applies to withdrawals from annuities during the accumulation stage. The 10% penalty does not apply to annuity payments received prior to age 59 ½, and does not apply to withdrawals from variable life insurance policies.

Generally, there is no death benefit with an annuity, but if the owner of an annuity dies during the accumulation stage, the beneficiary will receive the greater of: 1) The cash value of the contract on date of death 2) The decedent’s cost basis If the cash value exceeds the cost basis, the excess is technically a death benefit. If cost basis exceeds cash value, the beneficiary will have an ordinary income tax liability on any amount exceeding the decedent’s cost basis, but the 10% penalty will not be imposed.

When the owner of an annuity elects to begin receiving guaranteed monthly payments from the annuity, the contract is annuitized. The accumulation units are converted into annuity units and the contract enters the annuity stage. Annuitization should not be taken lightly, whereas the process is irreversible and cannot be altered or canceled. Upon annuitization, the owner relinquishes all rights to the cash value in the contract in exchange for the insurance company’s payout guarantee.

The four variables required to calculate the amount of an annuitant’s initial payment are: 1) Mortality -or- life expectancy of the annuitant (age and gender) 2) Assumed interest rate (AIR) 3) Cash value of the annuity contract 4) Payout option Higher Cash Value = Higher payout Higher Mortality = Higher payout Higher AIR = Higher payout Riskier Payout Option = Higher Payout

The available annuity payout options are as follows: • Life Income (Straight) The straight annuity payout option is the riskiest option, but has the highest monthly payment. The payments are guaranteed for life and cease at the death of the annuitant. • Period Certain The period certain payout option is more conservative than the straight option and results in a lower monthly payment. With a period certain payout option, monthly payments are guaranteed for the life of the annuitant and if the annuitant dies during the period certain, payments are

guaranteed to the designated beneficiary for the remainder of the period certain. • Refund The refund payout option is the most conservative and accordingly has the lowest payments. Should the annuitant die prior to receiving annuity payments at least equal to the cash value of the contract on the day of annuitization, the balance will be paid to the annuitant's designated beneficiary. • Joint Life The joint life annuity payout option covers two or more people, commonly spouses. The contract will pay monthly as long as one of the annuitants is living.

Depending on the contract, the payment may remain steady or may be reduced at the death of the first annuitant. Equity indexed annuities are fixed annuities that offer a guarantee against loss of principal if held to term. With an equity indexed annuity, interest credited is linked to the upward movement of a designated index, such as the Standard and Poor’s 500 (S&P 500). If the index moves upward, the interest rate is based on some portion of the increase. If the index moves downward, the equity indexed annuity does not lose value.

Market Value Adjusted Annuities Another fixed annuity product with a market driven aspect is the market value adjusted annuity. Rather than having the interest rate linked to an index, as with an equity indexed annuity, a market value adjusted annuity’s interest rate remains fixed. The market value adjustment feature applies only if the contract is surrendered before the contract period expires. If a market value adjusted annuity owner surrenders the contract early, a surrender charge and a market value adjustment will apply.

If interest rates decreased during the contract period, the adjustment will be positive and may add to the surrender value of the contract. However, if interest rates increased over the period, the adjustment will be negative and may increase the contract’s surrender charge. Marketing material of market value adjusted annuities must plainly state that the adjustment may be positive or negative.