Yukon Insurance Group

Family and Business Insurance

Understanding Annuity Contracts

The first thing to understand about an annuity is that it is, indeed, a contract, a formal, written agreement between an individual and a life insurance company that obligates both to a long term commitment. In return for a commitment by the annuity owner to keep a lump sum of money on deposit for a minimum period of time, the insurer is obligated to secure the deposit, credit it with a rate of interest, guarantee its return at the death of the individual, and then guarantee an income over the life of the annuitant or for a specified period of time.

The idea of a “contract” may scare some people, but, with the depth of obligation skewed toward the life insurer, it tends to work more in favor of the annuity contract holder which is why life insurers continue to experience record inflows to their annuity products. To understand how an annuity contract works is to understand just how much the life insurer is obligated to the annuity contract holder and how they provide such unique benefits. Essentially, an annuity contract is comprised of two phases, an accumulation phase and a distribution phase.

Accumulation Phase

For investors with a longer retirement time horizon, and no need for current investment income, a fixed or deferred annuity can be used to accumulate funds until they are needed. The contract includes an accumulation account to which the insurer assigns a fixed rate of interest. The contract spells out the details of the accumulation phase and all of the requirements and restrictions for the annuity owner.

Contract Ownership:

This establishes how the annuity is to be titled as an asset. In the event of the death of the annuity owner it will also dictate how and to whom the annuity contract is to be transferred .

Premium Payment:

Each contract specifies a minimum deposit amount that is accepted. Some annuities allow for additional periodic payments.

Interest Rate:

The terms for crediting interest are outlined including the length of time a rate is guaranteed and how future rates are determined. Annuity rates are usually based on the investment performance of the insurer’s portfolio and credited annually.

Minimum Rate Guarantee:

Specifies the minimum rate of interest that will be credited to the accumulation account. While insurers strive to credit account with competitive rates, a declining interest rate environment could push yields down severely, however, the insurer cannot credit a rate below the minimum guarantee.

Surrender Provisions:

These provisions allow for withdrawals to be made from the annuity at any time, however, if done so within a prescribed timeframe known as the Surrender Period, any amount withdrawn in excess of 10% of the value of the accumulation account will be charged a surrender fee. At the end of the surrender period, typically 7 to 10 years, there are no longer any surrender fees.


Aside from the fact that contributions to annuities are made with after-tax dollars, they are treated in the IRC much in the same way as qualified retirement plans. All interest earnings within the accumulation account are allowed to grow without current taxation and will be taxed as ordinary income when they are withdrawn. Also, any withdrawals made prior to the age of 59 ½ are subject to a 10% penalty by the IRS.

Death Benefit:

The contract includes a death benefit payable to a designated beneficiary. The benefit amount is, at a minimum, equal to the annuity owner’s principal investment.

Distribution Phase

This part of the contract details the process by which the insurer annuitizes the accumulation account and the requirements and options for the annuity owner. Once a contract is annuitized, the accumulation balance is irrevocably committed to the insurer.

Income Ownership:

An income option is selected as single life or joint life. If a joint life option is selected, the surviving annuitant will continue to receive payments based on the selected payment terms and payout rate.

Income Period:

This is the length of time, as specified by the annuity owner, that the insurer is obligated to make income payments. It could be for the lifetime of the annuitant or for a specific period of time.

Income Payout:

This is the formula that determines the amount of income that will be generated each month and it is based on several factors including the age of the annuitant, the life expectancy of the annuitant (which determines the number of payments), and a minimum rate of interest.

Refund Options:

In the event the annuitant dies before life expectancy, a selected refund option will determine the method and the amount of refund of the annuity owners balance will be paid to the beneficiary. Options no refund, cash refund, installment refund, or period certain refund.

Perhaps the most important element of the annuity contract is the financial ability of the insurer to fulfill its contract obligations. Simply put, an annuity contract is only as solid as the financial strength and integrity of the insurer. While an annuity owner has yet to lose any money from an annuity contract, which, in the 150 year history of annuities in this country, is a testament to their safety, companies with the highest ratings have the strongest balance sheets and reserves should be considered before others.

What are SPIA Annuities?

Single premium immediate annuities (SPIA) have been around in various forms for centuries. In their simplest form, they were a promise made to Roman citizens by the government to pay them an annual stipend for life in return for a deposit made to the government for its use. Similar arrangements were used by governments throughout the centuries and the deposits helped to finance wars as well as major construction projects. The SPIA of today is not very different in terms of its basic functions; however, the contract that is issued by a life insurer is a bit more complex than the simple arrangement of yesteryear.

SPIAA Essentials

SPIAA annuities are essentially used for the same purpose today that is to create a stream of income that lasts for a lifetime. Life insurers obligate themselves to that promise in return for a lump sum of money that they then invest in their own portfolio to generate a return that can be credited to the annuity balance as well as a profit for the insurer.

How do SPIA annuities work?

Upon receiving a lump sum deposit, which is an irrevocable investment on the part of the annuity owner, the insurer then makes a calculation to determine how much income can be paid out. The income period could be for a specific time frame, or for the life expectancy of the annuitant. Either way, the number of periods for which the income is to be paid is established. Then the insurer makes an assumption about the rate of interest the annuity balance will earn over that period of time. Using these two factors, a payout rate is established and fixed for the life of the contract.

When the income payments commence, typically within 30 days of the deposit, the amount paid includes interest earned on the account balance as well as a portion of the principal. The amount of principal that is returned in each payment is dependent on the number of pay periods. The objective is to pay out the entire principal by the end of the income period. The annuitant is only taxed on the interest portion of the payment.

At the end of the income period, the principal is exhausted and the income payments stop, except in the event that an annuitant lives beyond his or her life expectancy. Even though the insurer calculated the amount of payments based on an assumed number of years in which the annuitant would live, the insurer is obligated to continue to make the full payment for as long as the annuitant lives. This is the “insurance” aspect of annuities and the primary reason why people buy them.

How SPIA Annuities are Structured

A straightforward SPIAA would be structured as a single life annuity in which the income is paid to the annuitant, and if he or she should die before the end of the income period, the annuity balance is retained by the life insurer. In many cases, the annuitant is married and would want to ensure that the spouse was able to continue receiving income payments, so the SPIAA could be structured as a joint-life annuity. The income payments from a joint-life SPIAA would be slightly less than those from single-life because of the extra cost of insuring both lives.

Also, it’s not uncommon for an annuitant to want his or her heirs to receive some or all of the remaining annuity balance in the event that both spouses die prematurely. So, SPIAs can be structured to provide a refund of the balance, typically in installments. Some arrangements allow for a refund for a period certain after which a refund would not be available. These arrangements also add to the cost of the annuity which is recovered by reducing the income payment some more.

Additional Toppings

One complaint about SPIAs is that the fixed income it generates won’t help the annuitant over time when the cost-of-living increases. Most SPIA contracts allow for an inflation hedge option that, for an additional cost, will index the income payments to inflation.

What to Expect from an SPIA

SPIA annuities stand apart from other types of retirement income vehicles, and while they are not for everyone, they are unmatched in the benefits they can provide the right investor.


The principal balance and income payments are guaranteed by contracts issued by the strongest financial institutions in the country. Life insurers have a solid history of paying their obligations and those that receive the highest ratings (AAA from S & P and A++ from A.M. Best) are as rock solid as it gets.

Guaranteed lifetime income:

No other investment vehicle can do this.

Tax Advantages:

The interest earned on the annuity account balance is tax deferred. And, the income, as it is received, is only taxed on the interest portion.


SPIAs are also known as “sleep insurance” for those who might otherwise lie awake at night fearing that they might outlive their income source.

Are SPIA Annuities Right for You?

SPIAs are only suitable for anyone who has an immediate need for a guaranteed income stream. If you are retired and you want to build in an income safety net then an SPIA may be an appropriate investment. It is important to have available other liquid assets that can be used to cover short term needs or emergency expenses.

SPIAs are best used as part of an asset allocation strategy that includes short term liquid assets, some conservative growth investment, and other income investment. In that context an SPIA provides the stability that every retirement portfolio needs.

Indexed Annuities vs ETFs

Indexed investment have experienced a tremendous rise in popularity over the last few years as investors search for alternatives to direct stock market investing.  Two types of investments in particular have emerged as investor favorites: Indexed annuities and exchange-traded funds (ETF). While they share some of the same characteristics, the two are designed very differently and they are intended to meet different investment objectives.  A closer look at each of them will help you determine which one is most suitable for your needs.

Exchange-Traded Funds

ETFs are very similar to a mutual fund in that they are comprised of a basket of securities that mirror the securities that make up a widely followed index, such as the S & P 500. Unlike a mutual fund, the portfolio is not managed; rather it is kept static so that its performance will mimic the actual performance of the underlying index.  ETFs are available for commodities indexes and specific stock sectors as well.

They trade as a marketable security which means that they can bought and sold on the exchange at any time. The price fluctuates in response to movement of the underlying index, so an ETF can be purchased in the morning and then sold that afternoon for a profit if the index moves up. For that reason, ETFs appeal to investors with shorter term goals and who like the liquidity of shares.

Because it is a static portfolio, the fees for buying ETFs are fairly low, and because their returns are equivalent to the performance of the various indexes, they are ideally suited for investors whose objective is to match the performance of the indexes.

When ETF shares are sold for a profit, they trigger a capital gains tax which can be more favorable than the ordinary income tax rate.  Losses can be deducted from gains to reduce the tax consequences.

Indexed Annuities

Indexed annuities are a little more complex than ETFs, but they offer a whole different set of benefits. They are an annuity contract, which means they are issued by life insurers with certain guarantees and tax benefits.  As with any annuity the account values grow tax deferred and access to the values is restricted based on withdrawal fees that insurer may charge as well as possible IRS penalties that apply on withdrawals made prior to age 59 ½. And like most annuity contracts, they offer death benefit guarantees as well as a minimum interest rate guarantee.

That’s where the similarities end.  The distinguishing feature of indexed annuities is the accumulation account and the way the annuity rate is credited to the account values.  As with ETFs, indexed annuities tie the performance of the account value to a major stock index.  However, instead of allowing the values to simply move in tandem with the price movement of the index, the insurer applies a participation rate which will determine how much of the index gain is actually credited to the account.  So, if it applied a 70% participation rate on an index gain of 20%, only 14% of the gain is credited.  The rate is only applied once per year, and remains fixed for the next year.

Indexed annuities also include a limit or cap on the amount credited. The cap may be something like 10%, which means, instead of 14% credited, as in the example above, only 10% is credited. While this may not seem like such a great deal for investors, they need to consider the minimum guarantee feature which ensures that, even if the index should decline in value, the account will still be credited with a rate of return.  In essence, the account will never incur a loss.

Indexed annuities include a reset feature which adjusts the principal balance each year to include the gains achieved over the previous year, and because the account can never experience a loss, the principal balance, or basis in the contract, will continue to grow.

The income and withdrawals from indexed annuities are taxed like all annuities, as ordinary income when they are received.

Analyzing the Suitability of Both

Both investments are ideal for investors who want to add a more conservative element to their portfolio.  Both investments seek to track the performance of the underlying index. ETFs present more risk because the share prices can fluctuate, while indexed annuities are virtually risk-free. The more risk adverse an investor is, the more appealing an indexed annuity might be.

ETFs are suitable for investors who want the flexibility and liquidity that share trading offers, while indexed annuities are better suited for people who are able to invest for a long term horizon. Even with indexed annuities, there is access to account funds for meeting short term needs.

Investors looking for a tax edge could do well with either investment. If ETF gains qualify for the favorable capital gains rate, that could prove better than the ordinary income tax rate paid on annuity income.  The key difference is in the investment objectives. A person who is able to invest and hold for the long term may fare better with an index annuity with its continuous tax deferral.

Ideally, a mix of both investments would serve any investor with a conservative tilt and a long term horizon well.  ETFs are ideal for younger investors who are seeking short term gains while indexed annuities are better suited for slightly older, retirement-minded investors.





Best Sources of Retirement Income

Perhaps the most shocking development to spring from the economic malaise of recent years is the precarious state in which many Baby Boomers find themselves as they approach the cusp of retirement.  Reports are pouring out on the ever dimming prospects for a secure retirement for millions of Boomers who have suffered through one of the worst recessions in history.   Chalk it up to a decade of poor stock market returns, the elimination of defined benefit plans, and a pitifully low savings rate over the last ten years.  Going forward, for the Boomers and future generations, it has become critically important that only the best sources of retirement income be considered for a secure future,

The experience of this retiring generation has clearly shown that we can no longer rely on any one source of income and that sound retirement planning needs to incorporate a mix of sources that, when combined, can provide income longevity as well as stability.  Over the years, more products have come out designed to give retirees more control over their investment income. Among the many retirement income vehicles available, two are being touted as the best sources for providing a sustainable and stable income.

Target Retirement Funds

Among the more recent innovations in mutual funds is the target retirement fund which is based on the premise that a portfolio can be managed to parallel a pre-retiree’s evolving risk tolerance as the retirement date approaches, and then continue to manage it to generate an income for the life of the retiree or until it runs out, whichever comes first.

The target date is the retirement date (or any date selected) and the portfolio is allocated among stocks, bonds and other securities.  As the time horizon shortens, the allocation is gradually adjusted to a more conservative allocation. At retirement, a calculation is made to determine an amount of income that can be paid out over the retiree’s life based on an assumed rate of return.

Among the concerns that some retirees have is that these funds tend to remain invested in stocks or risk oriented securities more so than they think is safe.  However, as recent experience has shown us, retirees are in greater need of growth-like returns on their retirement assets in order to stretch them through their retirement years.

Target retirement funds are subject to market risk which could impact the amount of income available over time, and they should only be considered by pre-retirees who have at least a 10 to 15 year time horizon.

Immediate Annuities

The only individual retirement vehicle that can guarantee a lifetime of income is an immediate annuity. In exchange for a lump sum deposit, a life insurer will promise to pay a stream of income that is calculated to last until a person’s life expectancy or death, whichever is later.  The payout is based on the age of the person in relation to his or life expectancy and the interest rate credited to the annuity balance.  Because a portion of the payout is a return of principal, the older a person is at the time of annuitization, the higher the payout.

In a fixed immediate annuity, the income payments are fixed for the duration of the annuity, so, over a long period of time, they are not likely to keep pace with the increasing cost of living. Some annuity contracts offer an inflation rider that, for an additional cost (which is deducted from annuity payments), will adjust payments based on an inflation index.

Alternatively, a variable immediate annuity, in which the annuity payments are tied to the performance of the stock and bond markets, could potentially generate an income that, over time, will outpace inflation.  There is a risk that income could decline in down markets, however, most contracts include a minimum income guarantee, or one can be added for an additional charge.

Choosing the Right Source

As with any investment, the right income source for you is going to be based on your own financial situation, needs, risk tolerances and investment preferences.  Forward looking retirees are coming to the realization that they are going to need some combination of growth and income predictability if they are going to enjoy a comfortable retirement.  The best option for most people is to create some combination of vehicles which, when working together, can provide the ideal level of security, growth and income stability.

A strategy that combines a vehicle such as a target retirement fund (if you are younger than age 60) and an immediate annuity can be structured to optimize asset growth while ensuring that your income will last a lifetime. Depending on your age and risk tolerance, a larger portion of your assets can be invested in a target fund that can potentially keep your assets and income growing.

Another portion can be invested in a deferred annuity which can be converted to an immediate annuity at a later point in your retirement.  The immediate annuity can provide the additional income you might need to cover cost of living increases, and it also creates the assurance that you won’t outlive its income.  By waiting until you are older to annuitize, your income payout will be higher due to the return of principal.

While this particular strategy may or may not work in your situation, the bottom line is that it will take some creativity and some combination of tools and resources to ensure that you won’t join the millions of Boomers who are now lying awake at night.


Are Annuities Safer than Mutual Funds?

The short answer to the question, “Are annuities safer than mutual funds?” is yes, in a number of ways. However, rather than just take it at face value, a closer examination of the two different types of investments will reveal how they differ in the amount of safety investors should expect from each.

Mutual funds are an exceptional investment vehicle, as much for their potential to generate solid market returns as for the access to the markets they provide average investors.  They provide diversification and professional management which go a long way to mitigate the risk that would otherwise be too great for the average investor to assume. .  With the wide variety of mutual funds from which to choose, investors can create a complete portfolio that is balanced and diversified to their specific risk tolerance and investment preferences.

But, the reality is that mutual fund investors risk the loss of their investment value.  Except for money market mutual funds, which invest in very short term debt instruments, all mutual funds invest in stock or bond portfolios which are all subject to the price fluctuations of the markets.  Technically, mutual fund investors won’t lose any money unless they sell their shares after they have declined in value, but they must endure the possibility that their investment may not recover its value within the timeframe they require.

Annuities Are Built for Safety

Annuities were designed with built-in protections and guarantees that afford investors the assurance that their principle is not at risk.  The amount of protections and guarantees vary in degree depending on the type of annuity.  All annuities guarantee the return of principle upon the death of the annuity owner and some types are structured to protect the principle during the accumulation phase of the annuity contract.

Fixed Annuities

Fixed annuities are considered the safest of all annuities. With minimum guaranteed rates of return and safety of principle as their primary objective, fixed annuities provide the greatest degree of protection for investors.  In the nearly 200 year history of annuities in this country, not one annuity owner has ever lost money.  Life insurance companies, considered to be the strongest and most stable of all financial institutions fully back the principle with their general account assets which are invested in high quality debt securities.  Life insurers are also required to maintain very strict reserve and surplus ratios which are scrutinized by state regulators.

Variable Annuities

Variable annuities share one primary characteristic with their mutual fund cousins and that is their managed separate accounts consisting of stock and bond portfolios.  As such, these accounts can lose value in declining markets, and, as with a mutual fund, if a variable annuity was surrendered during a period of declining markets; it is possible for an investor to lose money.

Although the accumulation accounts are managed separately from the general account of the life insurer, it is the assets of the general account that back the return of principle death benefit. Many variable annuities include a minimum rate guarantee that can assure investors that their money will grow even in a declining market.

Additionally, variable annuity contracts offer guaranteed benefit options (for an additional charge) that guarantee a minimum death benefit, or a “rolled up” death benefit that includes a growth element.  Contract owners can also purchase options that guarantee a minimum income level or income tied to a certain growth rate.  While many of these guarantees increase the cost of owning a variable annuity, they provide protections not found in mutual funds.

Fixed Index Annuities

Index annuities are unique for their ability to provide investors with a return that is tied to stock market returns, yet have guarantees and protections that are closer to those of fixed annuities.  The yield that is credited to the accumulation account is based on a percent of the actual gain in the stock index to which the annuity is linked.  The insurer caps the upside potential, so an investor will not participate in the full percentage gain of the index, but in return, the insurer guarantees that the account will earn a minimum rate during when the index declines.

The reset feature of fixed index annuities, in which the account values are reset each year to lock in the previous year’s gain, ensures that not only is the principle protected, but that any yearly gain is also protected and forms the new basis of the account.

Find out more by visiting the following page: Annuities Explained.

At What Price Safety?

There really is no question that annuities are safer than mutual funds. With all of the inherent and optional guarantees available in annuity contracts, it is fairly difficult to lose money except in the highly unlikely instance of a life insurer failing to meet its obligations. In the rare instance when a life insurer’s reserves fell below its outstanding obligations, the assets of the insurer were purchased by or merged with another insurer preventing any default to its annuity owners.

All of these protections and guarantees do come at a price. Annuities have fees and expenses associated with them that mutual funds do not.  The question investors, especially those who have taken a beating in the market, have to ask, is, how much is peace-of-mind worth?