Annuity Products: How Do They Work and Which Are the Most Popular?

Written by Matthew King, time it takes to read this article is  minute(s).

According to the Sales & Market Report, in 2020 there was $209.1 billion in annuity sales. The first quarter of 2021 saw $58.1 billion in deferred annuity sales.

The report also found that variable annuities are the most popular of all annuity products. This is followed by indexed annuities and then fixed annuities. Variable annuity sales show a 17.6% increase from 2020 to 2021.

If you are new to insurance sales or have not yet added annuities to your product offerings, this is an excellent way to grow your business and increase your salary.

Keep reading to learn everything you need to know about this lucrative area of insurance sales.

What Is an Annuity?

An annuity is a type of insurance contract. The purpose is to pay out the invested funds as a fixed income stream at some point in the future. Payments are usually made during retirement.

How Annuities Work

The annuity goes through two steps to create the guaranteed income:

  • Accumulation phase—investor funds the annuity by making either a lump-sum payment or by paying monthly premiums
  • Annuitization phase—also called the payout phase, during which the annuitant (owner) begins receiving payments from the invested funds

The annuitant receives payments for either a set period of time or for the rest of their life.

The annuity may fall into the category of immediate or deferred. The structure may be either fixed or variable.

This product is often the choice of those who do not believe their assets will sustain their standard of living during retirement. The cash the client invests into this product is illiquid and is subject to withdrawal penalties.

What Is Illiquid?

Financial institutions use the term illiquid when referring to any type of asset that is not easily sold or converted into cash without a substantial loss.

The reason annuities are illiquid is that there is low interest or trading activity. Investors are not looking to sell their annuities.

Illiquid is the direct opposite of investments that have liquidity.

Liquidity is the term financial institutions use when referring to any asset that is easily converted into cash with no effect on its market price. Cash is a liquid asset.

Special Considerations When Selling Annuities

When promoting an annuity to a potential client, you must make them aware of special areas they need to consider before making a purchase. This includes the surrender period.

The surrender period is the amount of time that the investor must wait before they can begin withdrawing funds without a penalty. The period of time varies depending on the specific annuity.

Annuities are not the only financial product with a surrender period. This is also found in whole-life insurance policies and B-share mutual funds.

Annuity insurance contracts have an income rider. That rider provides the investor with the guarantee of a fixed income.

Those who purchase an annuity do not suffer the risk of longevity, causing loss of income. Helping the client understand they are providing liquid cash in exchange for a guaranteed cash flow during their retirement boosts sales.

Types of Annuity Products

Annuities provide a guaranteed income. This can be for a specified period of time or their lifetime. It may also be for a surviving spouse’s lifetime.

The type of annuity determines when payments begin, how long they last, and whether the payments are fixed or variable.

Immediate Annuity

Immediate annuities are frequently bought by people who suddenly receive a lump sum of cash. This may be an inheritance, lottery win, or lawsuit settlement.

This type of investment may begin paying out almost immediately following its purchase.

  • The owner determines whether to receive payments monthly, quarterly, or annually
  • The payment amount is fixed for the entire term of the contract

Because the annuitant is receiving a fixed payment, the insurance company calculates the amount of the payment based on:

  • Annuitant’s age
  • Prevailing interest rates
  • Period of time payments to be made

The immediate payment annuity is popular with those who need to supplement their retirement income for the remainder of their life. The owner may also designate a specific period of time, such as 5-10 years rather than life, to receive payments.

Deferred Annuity

A deferred annuity is designed to grow on a tax-deferred basis. It provides the owner/annuitant with a guaranteed income that begins on a date specified by the owner. The owner may also elect to take a lump-sum payment at some time in the future.

Deferred annuities are available as a variable, fixed, or indexed. The type of annuity will determine the rate of return.

If the owner makes a withdrawal from the annuity prior to reaching 59-1/2 years of age, they will be subject to both a surrender charge plus a 10% tax penalty. The 10% penalty is in addition to the income tax they pay against the funds withdrawn.

Because this is a tax-deferred investment, the annuitant only pays taxes at the time of withdrawal. The payments they receive are subject to their tax rate at that time.

Variable Annuity

The value of this annuity varies depending on the performance of the portfolio sub-accounts. The annuity owner selects the sub-accounts.

Because of the variable investment factor, this annuity may offer higher returns and income than a fixed annuity. There is also the risk that the account value will fall.

The advantage of a variable annuity is the ability to profit from rising markets. The product comes with a guaranteed death benefit, and the funds are off-limits to creditors.

The disadvantage is this is a riskier investment because of market risk. If investments do not do well, the lower cash flow results in a lower payment amount.

Fixed Annuity

This annuity provides the promise of a guaranteed payment and a guaranteed interest rate on the investment. The earnings are tax-deferred until the annuitant begins receiving payments.

When the owner begins taking payments, the amount of the payment will be calculated based on:

  • Owner’s age
  • Amount of money in the account
  • How long are payments to continue

The payment period may be a set number of years or the lifetime of the owner. Taxes on the account are based on whether this is a non-qualified annuity or a qualified annuity.

Non-qualified annuities are not held in a qualified retirement plan. The accounts are subject to taxes only on the portion of the payment that is attributable to interest gains.

In a qualified annuity, the entire payment is subject to taxes.

Indexed Annuity

This annuity contract pays interest that is based on a specific market index, such as the S&P 500. The annuity benefits the owner when the financial market is performing well.

The downfall is some provisions in the contract may limit the upside increase to only a portion of the market increase.

Indexed annuity calculations are made on the average monthly gain over twelve months. It may also be calculated using a year-over-year comparison.

The benefit to the owner depends on the terms of the contract. The participant rate of increase is usually around 80-90% but can be as high as 100% or as low as 25%.

Only Available Through Licensed Insurance Agents or Brokers

You must have a state-issued life insurance license to sell annuity products. If you plan to sell variable annuities, you must also have a securities license.

That is because annuity products fall under the regulations of the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC). The FNRA works under the supervision of the SEC to safeguard the integrity of the investment market.

If you are interested in selling annuities or any other type of insurance but do not know what the job entails, it is pretty simple. After getting your license, you sell insurance policies to customers.

The career of an insurance salesperson is flexible. You do not have to work a set schedule or report to an office every day. You do need to learn about the products you promote.

Are Annuities a Sound Investment?

Annuities are a sound investment for retirement. They provide the owner with a steady income, grow tax-free, and are taxed at the retiree’s tax base at the time of withdrawal.

Adding an annuity to a retirement portfolio is a great way for clients to increase their retirement income. If the client is continuously maxing out their 401(k), IRA, or other retirement accounts, this is an alternative investment opportunity.

Another consideration is that as people age, they have less interest or ability to keep up with their investments. As their cognitive abilities to manage investments decline, they just collect their monthly check.

Are you interested in this lucrative area of insurance sales? Do you have questions about where you can receive additional training and support?

Click here for information on where you can receive training and/or improve your sales techniques.

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