Annuity Contract: What It Means and How It Works

Updated July 15, 2024

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What Is an Annuity Contract?

An annuity contract is a written agreement between an insurance company and a customer outlining each party's obligations in an annuity agreement. Such a document will include the specific details of the contract, such as the structure of the annuity (e.g. variable or fixed); any penalties for early withdrawal; spousal and 澳洲幸运5官方开奖结果体彩网:beneficiary provisions (such as a survivor clause and rate of spousal covera✤ge); and more.

Key Takeaways

Annuities are often complicated financial vehicles designed to provide retirement income.
A beneficiary can inherit an annuity contract upon the annuitant's death.
An annuity contract can encompass up to four entities: issuer (usually an insurance company), the owner of the annuity, the annuitant, and the beneficiary.

How an Annuity Contract Works

An annuity contract is a contractual obligation between as many as four parties. They are the issuer (usually an 澳洲幸运5官方开奖结果体彩网:insurance company), the owner of the annuity, the 澳洲幸运5官方开奖结果体彩网:annuitant, and the 澳洲幸运5官方开奖结果体彩网:beneficiary. The owner is the person who buys an annuity. An annuitant is an individual whose life expectancy is used to determine the amount of the payout and when benefits payments will start and cease. (In most cases, though not all, the owner and annuitant are the same person.) The beneficiary is the individual designated by the annuity owner who will receive a 澳洲幸运5官方开奖结果体彩网:death benefit when the annuitant dies.

Fast Fact

The⛎ annuity owner and the annuitant are often the same person, but not always.

What to Watch Out for

When shopping for an annuity, keep an eye on multiple-tier contracts for withdrawing money. Tier 1 allows for withdrawals over a lifetime (or annuitization value—basically, an 澳洲幸运5官方开奖结果体彩网:immediate annuity payout). Tier 2 may be enacted if the annuity owner wants to take out their entire balance as a 澳洲幸运5官方开奖结果体彩网:lump-sum payment, in which case the annuity seller may reduce the value of benefits by 10% or even 20%. The key is knowing if an annuity contract includes multiple tiers and what penalties may be triggered if the owner wants to 澳洲幸运5官方开奖结果体彩网:liquidate their annuity.

Also keep in mind that insurance companies offer high teaser rates to entice buyers—to get them in the door—but these rates don't last long. They can be quickly followed by far lower rates for the life of the annuity contract. The way around this issue is to require the annuity seller to fully disclose the 澳洲幸运5官方开奖♚结果体彩网:rate you will pay for the life o꧑f the annuity.

Annuity contracts have different withdrawal amount policies—make sure they are flexible. For example, many have a 10% withdrawal amount, but if you want to defer and instead withdraw 20% after two years, make sure that is an option without a penalty (i.e., for a cumulative withdrawal).

What Happens When You Are the Beneficiary of an Annuity?

When you (as an individual or an organization) are designated as the beneficiary of an inherited annuity, you gain possession of the annuity, typically after the owner has died. (Note: This is based on the owner's death, not the annuitant's. The owner and annuitant are usually the same person, but not always.)

You will have essentially three options: withdraw funds in a lump sum, receive periodic payments for the rest of your life, or follow what is called the five-year rule, which states that you must ไwithdraw the entire balance over five years. Note: These rules—and the taxes involved—can be complex, so consider consulting a financial professional.

How Long Does an Annuity Contract Last?

An annuity contract can last for many years or less than one, depending on how long the owner lives and whether they named a beneficiary. A 澳洲幸运5官方开奖结果体彩网:period-certain annuity lasts for the number of years that is specified in the contract. An annuity with a death benefit might extend for as long as the beneficiary is alive—so the annuity owner's lifetime, plus the beneficiary's lifetime.

In general, the payout depends on the length of the annuity. A period-certain annuity, which is limited in duration, will typically have a higher payout per month, quarter, or year than a 澳洲幸运5官方开奖结果体彩网:life annuity, or an annuity with a rider that outlined a 澳洲幸运5官方开奖结果体彩网:death benefit for a beneficiary or beneficiaries.

What Is a Surrender Period for an Annuity?

A 澳洲幸运5官方开奖结果体彩网:surrender period is the period during which 𓆏an annuity owner will be pena🗹lized for withdrawing their money from an annuity. A surrender period typically lasts years, sometimes a decade or even more.

If you withdraw funds from your annuity during the surrender period, you'll be hit with a 澳洲幸运5官方开奖结果体彩网:surrender fee, which can be in the double digits. The fee typically decreases every year that passes as the surrender period continues, until the surrender period ends and the fee is at zero. For example, the surrender fee might be 15% for the first year of the annuity contract, and then go down by 1% per year, until the end of the 15th and final year of the surrender period. So at the end of 15 years, you'll be able to withdraw funds fee-free—as long as it's under certain limits (such as 10% of the total annuity).

Rules vary, so make sure to read the fine print.

What Is an Indexed Annuity?

An indexed annuity, or an 澳洲幸运5官方开奖结果体彩网:equity-indexed annuity, is a type of fixed annuity. This complex, moderately risky insurance product tracks the performance of a particular index, such as the 澳洲幸运5官方开奖结果体彩网:S&P 500. However, it does not participate in the market, like a var🎃iable annuity.

The Bottom Line

As an investor planning for retirement, you might think an annuity contract would be a good idea, because it legally requires an insurance company to provide a guaranteed periodic payment to the annuitant once the annuitant reaches retirement. Essentially, it guarantees retir🐼ement income.

However, annuity contracts may not be worth it for many investors. Annuities can be complex, and the associated fees can be high. The amount of return may not keep pace with 澳洲幸运5官方开奖结果体彩网:inflation. Do your due diligence and weigh the pros and cons c🅘arefully before signing up—if you decide to sign up at all.

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