The Players Involved in the Annuity Process

by Rob Phillips, CPA

Non-qualified variable annuities have a cast of players, which include the owner, the insurance company, the annuitant, and the beneficiary. Their relationships to each other are spelled out in the annuity contract.

The Owner: Owning the Annuity Contract

When buying variable annuities, you select the annuity contract and name the annuitant and the beneficiary. You also allocate the premium among the investment portfolios offered through the contract. And finally, you decide how and when the annuitant will receive the annuity payments.

If you’re buying the annuity contract as part of your retirement savings strategy, typically you’ll be the annuitant as well as the owner. You can choose to receive the annuity payments as a lifetime income stream, or designate your spouse as a joint annuitant, so that the contract could provide annuity payments to last through both your lifetimes.

There are circumstances, though, when you might buy an annuity contract to provide income for someone else—for example, a disabled child—for whom you have financial responsibility. In those cases, you would be the owner but not the annuitant.

The Company

An insurance company, either by itself or as part of an agreement with another financial institution (such as a mutual fund company), offers annuity contracts and assumes a number of responsibilities on behalf of the owners.

Those jobs include administrative tasks such as administering the terms of the contract, maintaining your account values, and providing regular account information. Also included are financial duties such as assuring that premiums are invested according to the owner’s wishes.

The responsibility that’s unique to an insurance company is standing behind the guarantees in an annuity contract, such as the death benefit and the option of lifetime annuity payments.

The Annuitant

The annuitant is the person designated to receive income from the annuity contract and whose life expectancy is used as the basis for figuring lifetime annuity payments. While the annuitant doesn’t make contract decisions (the owner does), the annuitant has a major impact on the terms of the contract.

Unlike the owner, the issuer, or the beneficiary, the annuitant must be an actual (living) person, typically age 75 or younger at the time the annuity is purchased.

The annuitant’s life expectancy when the income payments begin is key to setting the amount of the annuity payments and affects the percentage of each payment that will be taxable.

The annuitant’s life expectancy for those tax purposes is determined using tables issued by the Internal Revenue Service (IRS). For example, if the annuitant’s age is 65, his or her life expectancy currently is 20 years, until age 85.

The Beneficiary

 The beneficiary receives a death benefit from the annuity contract if the owner dies before the annuity payments begin. The contract also pays the beneficiary, when annuity payments are guaranteed for a certain period and the annuitant dies before that amount of time has passed.

The beneficiary can be a person or persons (including the owner if he or she is not the annuitant), a charity, or a trust. The contract owner names the beneficiary and usually has the right to change that designation at any time.

Most annuity contracts allow the owner to list multiple beneficiaries, so that the death benefit or income can be divided among them when the annuitant dies. When there are multiple beneficiaries, the owner must assign a percentage value of the annuity to each beneficiary. That’s because it’s impossible to predict the future value of variable annuities.

By using a percentage, each beneficiary gets a proportionate share. For example, a mother might name her son and daughter as beneficiaries with each to receive 50% of the annuity. That way, the assets could be shared evenly, in keeping with the mother’s wishes.

Older is Better

The curious thing about life expectancy is that the older you get, the longer you can expect to live. If you’re 65, you’ll typically live until you’re 85, but if you are 75, your life expectancy is another 12½ years, or 87½. If you live until 87½, you can expect— statistically—to live until you’re 93.

If you live until 93 or even 103, variable annuities guarantee lifetime income will pay that long, no matter what your life expectancy was at the time your annuity payments began.

Annuities as a Gift

 While most people will buy annuities to provide retirement income for themselves and their spouse, the taxdeferred growth that annuities provide can be put to work for younger people as well. For example, you might buy each of your grandchildren a single premium annuity on their 10th birthday, explaining that it’s a start on building their own retirement security—even if that’s 55 or more years away.

As long as the premium is less than the annual ceiling on tax-exempt gifts, there are no tax consequences for you, and none for the recipient until he or she begins to take income.

Who Else Can Be an Owner?

Though a person is typically an annuity owner, there are others—a trust, partnership, corporation or employer—who can own annuity contracts naming a specific person as the annuitant.

If a trust, partnership or corporation owns non-qualified annuities purchased since 1986, the earnings generally may be taxable each year, effectively wiping out the tax advantages of owning an annuity contract. However, there are some exceptions to this rule.

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