Parties to an Annuity Contract

An annuity contract involves three different parties - the owner, the annuitant and the beneficiary.
The owner is the party on the annuity contract who owns the annuity and has the right to change the beneficiary, and on deferred contracts, the right to withdraw funds, make additions, and in some cases change the annuitant or add or change the ownership.
The annuitant is the party on the annuity contract who is normally the measuring life.
The beneficiary is the party who receives proceeds at death of owner or annuitant.

An annuity is, for our purposes, the product of an insurance company. Therefore, there is an insurance provision included. Generally it will guarantee your money placed in a variable will come back to you if the annuitant dies. It may also provide 'step ups' to its highest value reached during the investing or holding phase; sometimes the step up will be annually, and some will do it quarterly. If the variable has not yet recovered from the down turn, the payout will be the highest value less pay outs when the annuitant dies.

In our family we had a situation where an annuity for grandmother was the right product, but she had cancer and could not be the annuitant. (This was years ago and she is still doing fine.) We made one of the daughters the annuitant, grandmother is the owner, and both daughters are the beneficiaries. This allowed us to accomplish what we wanted by deferring taxes and providing some protection of grandmother's wealth in case she went to a nursing home.

. We have defined what a beneficiary is, but were you aware that there are classes of beneficiary? The following information applies to annuities and all retirement plans such as an IRA, 403b, 401k and the like. The owner must identify the "Primary, or Class I Beneficiaries" who are to receive the proceeds should annuitant and/or owner die. But if a beneficiary precedes the forgoing in death, a "Contingent, or Class II Beneficiary" will become the beneficiary of the share of the Primary. Quite often several beneficiaries are named, for example; above where there are two daughters listed as beneficiaries, we structured her contract so that if one daughter predeceases the grandmother, that daughter's share will be divided among her children.

This is an important point! These contracts can be written per stirpes, a legal term meaning "to follow blood". Per stirpes directs the money to the children/grandchildren and so on of the daughters and not to the husbands. The purpose is to protect money for the blood family members. It prevents the money from going to that son-in-law who after your daughter passes away, remarries and leaves everything to kids of the new wife. This is probably the worst case scenario but that is why per stirpes exists. This term may not appear in any of your documents but the thrust of the meaning should be there.

Per Capita: Some insurance companies assume per capita rather than per stirpes. The term per capita means that when more than one beneficiary is named and one dies before distribution, all will go to the living primary beneficiaries, and not to the children of the deceased. A potential murder mystery plot?

Percentage Distributions: Indicate that beneficiaries are designated a specific percentage of the contract. Once again, an insurance company would like to assume per-capita if one beneficiary predeceases distribution. Why? It makes life easier for the insurance company not to have to track down great-great grandchildren. By the way, we have seen the situation where one of the kids is dis-inherited by the parents. If this situation exists, do not just omit the child, instead leave him/her one dollar, this will help resolve certain legal issues.

The Annuity Contract

The annuity contract contains important information and provisions. This contract is given to the client once the policy has been issued. The annuity owner has a certain number of days from the date the contract is received to review it. This period of time is known as the free-look period. If the owner decides not to take the policy within the free-look period, the insurance company will return the payment in full to the owner.

Features
Competition and customer demands have spawned a multitude of features that are commonly found in today's annuities. We offer a summary of most of these features but if you are seriously looking at purchasing an annuity, you should examine the possibilities in greater detail than has been offered here.

Tax Deferral: Deferred annuities, as noted above, are tax-deferred instruments as long as they meet IRS requirements. Under IRS guidelines, earnings from an annuity are not taxed until withdrawn. The difference between tax-deferred growth and growth on a taxable instrument can be significant, depending on the holding period and your tax bracket.

Probate Avoidance: Annuities, as a life insurance product, can avoid probate. The death benefit is paid directly to the beneficiary. If the estate of the deceased is named as the beneficiary, the annuity proceeds will be probated before distribution to heirs of the estate. If the deceased is the annuity owner, the proceeds will be included in computing estate taxes.

Free Withdrawals: Most annuity contracts allow a specified amount to be withdrawn from the contract value without a withdrawal or surrender charge being applied. This feature is commonly known as the penalty-free withdrawal. Normally, surrender charges are applied to withdrawal amounts which exceed the penalty free amount.

Surrender or Withdrawal Charges: Annuities normally include an initial surrender charge period. A charge is applied to withdrawals greater than the penalty free amount for a specified period of time. We at Juniper Tree would not consider purchasing any policy with a penalty period exceeding eight years. Typically, penalties start at 7% for year one, 6% for year two and so on.

Principal Guarantee ensures that if the annuity owner makes a full surrender, after a certain holding period, he/she will never receive less than the principal contributed or perhaps has been 'stepped up'. Surrender charges may apply and reduce the pay out for amounts greater than the free withdrawal provisions. Note that the IRS regulations would treat any of the withdrawals as being gains first (making them taxable) even though the insurance contract treats the withdrawals as principal first for the purposes of principal guarantee provisions. Everyone has their own agenda.

Systematic Withdrawals: Systematic withdrawals allow regular payments to be withdrawn from an annuity without locking you into a payout schedule, as Annuitization does. Systematic withdrawals can be paid monthly, quarterly, or annually. Systematic withdrawals may be stopped and started and withdrawal payments may be changed.

Medical or Nursing Home Waivers: This feature allows for withdrawals without the normal surrender penalties. Conditions for qualifying under a nursing home waiver vary, but generally a stay of a specific length in a licensed facility will allow the waiver provision to apply.

Tax-Free Exchanges: An annuity contract may be exchanged for another annuity contract without tax consequences under certain conditions. The Internal Revenue Code Section 1035 allows for an exchange of life insurance policies, (annuities) with no tax consequences, these exchanges are often referred to as 1035 exchanges. It may be a good idea, depending on whether the circumstances fit the required conditions but remember that the penalty period will start all over again.

Taxation Rules at Death Generally a beneficiary has the same basis in the annuity contract that the owner did and may face requirements for distribution over the next few years. The rules are similar those of retirement plans and can be complex. If you are facing this one, seek qualified help in how to best conform to the rules. Even a planner must be careful here.

Annual Expenses Normally there are no 'up front' fees or charges when purchasing an annuity. However, there are ongoing costs you typically do not see. They still have the effect of reducing your return when compared to other types of investments. An annual contract fee is charged to each variable annuity contract holder. This fee is normally $30 - $35. Separate account expenses include mortality (the life insurance provision), administration and maintenance fees. Ask your insurance person about them.
An annuity can be a good investment vehicle, but it is one you need to fully understand as it can be difficult to extricate your investment once it has been established.