Annuities
Frequently Asked Questions
- What is an annuity?
- How can an annuity provide me with retirement payments as long as I live?
- What makes the variable annuity unlike any other investment?
- What are the potential benefits of asset allocation?
- What is the accumulation phase of an annuity contract?
- What is the payout phase of an annuity contract?
- What payout options are available?
- What are the different annuity share classes?
- How can I jump-start my annuity savings?
- What is a fixed annuity?
- What should I consider when choosing a fixed annuity?
- Why would I choose an annuity for my qualified plan?
- How does a living benefit work?
- Why invest in an annuity if I already have an IRA and participate in a 401(k) plan?
- Why should I consider a variable annuity from Morgan Stanley Smith Barney?
- Why is it important to start saving now for retirement?
- How do tax-free annuity transfers work?
- Can I transfer between investment options easily?
- How do "stepped-up" death benefits work?
- What IRS reporting is required for annuity owners?
- How can I find out more about variable annuities?
What is an annuity?
An annuity is a contract between you and an insurance company that allows you to accumulate money on a tax-deferred basis and arrange for a systematic stream of income payments, usually when you retire. Variable annuities are subject to investment risks, including the possible loss of principal.
back to topHow can an annuity provide me with retirement payments as long as I live?
If you annuitize your contract and choose a lifetime income option, you are guaranteed a stream of payments you cannot outlive, backed by the claims-paying ability of the issuing insurance company. (This guarantee does not apply to the investment performance of a variable annuity's underlying investment options.)
back to topWhat makes the variable annuity unlike any other investment?
You may direct funds into diverse portfolios appropriate for your risk tolerance and retirement expectations, choosing among different portfolios and fund manager families. The variable annuity is distinct in offering these choices, plus beneficiary protection and optional living benefits, all in one investment. Living benefits and death benefits are backed by the claims-paying ability of the issuing insurance company.
back to topWhat are the potential benefits of asset allocation?
Variable annuities allow you to easily diversify your investment among stocks, bonds, and money market portfolios. Many economists–including three 1990 Nobel prize winners–have shown that by diversifying assets, including the addition of some riskier assets, a portfolio has the potential to obtain the highest return potential for each asset class, and do it with a lower level of risk than the portfolio's assets would achieve separately. Of course, asset allocation does not protect against a loss.
back to topWhat is the accumulation phase of an annuity contract?
This refers to the period in which you make premium or purchase payments to the contract. These payments grow on a tax-deferred basis until withdrawn. Withdrawals of taxable amounts are subject to income tax and, prior to age 59½, the IRS may impose a 10% penalty. A surrender charge may be imposed by the insurance company if a withdrawal is made in excess of the free withdrawal amount during the early years of the contract.
back to topWhat is the payout phase of an annuity contract?
The payout, or income phase, refers to the period when you will receive regular income payments from the annuity. Income payments are based on the value of the contract at the time the option is elected. Income guarantees are backed by the claims-paying ability of the issuing company.
back to topWhat payout options are available?
Period certain–Income is guaranteed for a predetermined period of time.
Life with period certain–Income is guaranteed for the rest of your life or for a predetermined period of time, whichever is longer. If you die before receiving the minimum number of guaranteed payments, the remaining balance is paid to your beneficiary.
Joint and survivor–Income is guaranteed for the lifetime of two persons (typically spouses) for as long as either is alive. A period certain may be added to this option.
Life only–You will receive income for the rest of your life. Payments cease at death of owner with no payments to the beneficiary.
Note that all guarantees are backed by the financial strength of the issuing company.
What are the different annuity share classes?
B Share annuities do not have an initial sales charge, but do have a contingent deferred sales charge. Also known as a Surrender Charge, you will pay this sales charge when you make a partial or full surrender from the annuity. The product prospectus will specify the terms of the surrender schedule. A typical surrender schedule averages 6-8 years, with the surrender charge ranging from 5%-7% and decreasing by 1% each year the contract is in force, until it reaches zero. Most B share annuities impose the surrender charge during the initial period that begins after the contract is purchased. However, some will begin a new surrender charge period with each subsequent payment. Once the surrender charge period ends, the contract is out of surrender and no further surrender charges will apply to withdrawals. However, withdrawals are still subject to income tax and, if taken prior to age 59½, a 10% IRS penalty tax.
C Share annuities provide more liquidity for investors by allowing cash surrenders without the front-end or back-end surrender charges associated with traditional variable annuities. However, as with all annuities, withdrawals of taxable amounts will be subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% IRS penalty.
L Share annuities are the newest pricing option. Similar to B shares, L shares also have a contingent deferred sales charge (Surrender Charge). L share annuities provide the flexibility of a shorter surrender charge schedule averaging 3 to 4 years. As with B shares, there is a declining surrender schedule, and withdrawals of taxable amounts will be subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% IRS penalty.
back to topHow can I jump-start my annuity savings?
Premium-enhanced, or bonus, variable annuities offer the purchaser a purchase payment credit, or bonus, on their premium. This credit is a percentage applied to the purchaser's premium payment.
Purchase payment credits are treated as earnings for distribution purposes and may be subject to income tax. They are also subject to investment risk when invested in the variable annuity subaccounts. Variable annuities featuring a premium enhancement may have higher charges and fees and longer surrender periods than traditional variable annuities. The product's prospectus provides more detailed information about the charges and fees.
back to topWhat is a fixed annuity?
Fixed annuities allow you to lock in a guaranteed rate of return for a predetermined period of time. At the end of this period, the insurance company may issue a new rate for the succeeding period. Additionally, the issuing company guarantees a return of the principal and rate paid into the contract. With these types of guarantees, a fixed annuity may provide a fixed and steady income during the payout phase. All guarantees are based on the claims-paying ability of the issuing insurance company.
What should I consider when choosing a fixed annuity?
Since the rate of return is fixed, it is important to consider the effects of inflation on your investment. It is also important to note that the assets are invested in the insurance company's general account and are therefore subject to the claims of its creditors. With this particular type of annuity, you will want to consider the financial strength of the issuing company. Consumer rating services such as A.M. Best and Standard & Poor's provide such information.
back to topWhy would I choose an annuity for my qualified plan?
Annuities offer no additional tax deferral than that offered by a qualified plan and investors should always consider contributing the maximum allowable to their qualified plans before investing in annuities. Withdrawals from qualified plans and annuities of taxable amounts are subject to income tax and, before age 59½, a 10% IRS penalty. Surrender or withdrawal charges may also apply for annuities. There are, however, benefits you may want for your qualified plan that are available only in a variable annuity.
Variable annuities offer death benefits which typically guarantee the amount invested (less withdrawals, charges, and withdrawal adjustments). Some contracts also offer "enhanced" or "stepped-up" death benefits for an additional cost. This type of death benefit is designed to "lock in" your investment performance and/or guarantee a minimum return on the value of your account. The product prospectus can give you more information about living benefit and death benefit options, charges, restrictions and limitations.
For an additional fee, many insurance companies also offer living benefits—guarantees to protect your accumulated assets during your lifetime and provide a regular stream of income during retirement.
Such guarantees, backed by the claims-paying ability of the issuing insurance company, have helped make the variable annuity popular among investors saving for retirement.
back to topHow does a living benefit work?
Living benefits can assure you a minimum monthly income when you begin taking payments, or the return of your original investment, regardless of the value of your annuity contract when you activate the benefit. You pay for these optional guarantees only if you want them. They typically have a vesting period and are backed by the claims-paying ability of the issuing insurance company. Some are irrevocable. Guarantees and fees vary by contract. Read the prospectus for complete details.
The three main types of living benefits are:
Guaranteed Minimum Income Benefit
Generally this benefit guarantees income through a guaranteed minimum annual compounding rate, typically ranging from 4%-5%. This rate is guaranteed regardless of market conditions. Typically, a 10-year holding period applies. Guaranteed Minimum Income Benefit riders require that the contract be annuitized to access the benefit.
Guaranteed Minimum Withdrawal Benefit
This benefit guarantees a return of principal over time, through systematic withdrawals. Typically, the amount of the withdrawal is about 7% annually for a period of 14 years. During the guarantee period, withdrawals from the contract, including free withdrawals, regardless of the amount, may negatively affect the death benefit. Withdrawals in excess of the free withdrawal provision may be subject to surrender charges. All withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, may be subject to a 10% IRS penalty. Withdrawal provisions will vary by contract. Some benefits also guarantee annual withdrawals for life, or for the life of the owner and the owner's spouse, in addition to guaranteeing the principal.
Guaranteed Minimum Accumulation Benefit
Generally, this benefit guarantees the initial investment. At the end of the vesting period, typically 10 years, if your contract value is below your initial investment, the issuer will add the difference between the current contract value and the initial premium (minus withdrawals). You are guaranteed to receive back at least what you invested. At the end of the vesting period, the benefit may be exercised, expired or renewed, depending on the terms of the contract. If the benefit is not exercised or renewed, the guaranteed amount will become subject to market risk and may lose value. If the benefit is renewed it will trigger the start of a new vesting period. Additionally, some contracts mandate that all of your assets be allocated in specified investment options to access the benefit.
Why invest in an annuity if I already have an IRA and participate in a 401(k) plan?
Each year, the amount you can contribute to an IRA or 401(k) is governed by IRS rules. For 2006 the maximum amounts are $4,000 for an IRA and $15,500 (or 20% of annual compensation, whichever is less) for a 401(k). There are penalties for withdrawals before age 59½, as well as rules that dictate when you must begin withdrawing money.
Annuities in nonqualified plans, where contributions are not deducted from current income taxes, place no limits on your after-tax contributions other than those set by the insurance company and have no deadlines that tell you when you must begin withdrawing. Annuities purchased in qualified plans are subject to minimum distributions required by the IRS. This can help you save more on a tax-deferred basis and keep more of your long-term earnings for use during retirement. Withdrawals from qualified plans and annuities of taxable amounts are subject to income tax and, before age 59½, the IRS may impose a 10% penalty. Surrender or withdrawal charges may also apply for annuities.
back to topWhy should I consider a variable annuity from Morgan Stanley Smith Barney?
Smith Barney is one of the nation's leading distributors of annuities, according to the MFS Annuity Managers Roundtable, with assets of more than $41 billion as of 2007. We offer a wide array of annuities from the nation's best-known insurance carriers–a selection that means we may have a policy appropriate for your overall financial strategy.
back to topWhy is it important to start saving now for retirement?
Americans are living longer. Retirement will be a bigger part of your life. How comfortable it is depends in part on how you supplement Social Security and pension payments with your own personal savings plan on a qualified or nonqualified basis.
The sooner you begin saving, the better. In its Saving Fitness guide, the Department of Labor estimates that for every ten years you delay saving, you will need to save up to three times as much each month to earn the same amount for your retirement.
back to topHow do tax-free annuity transfers work?
Internal Revenue Code Section 1035 allows you to exchange one annuity contract for another, or exchange a life insurance contract for an annuity–without having the transfer treated as a taxable event. A 1035 exchange may be appropriate if you own an older contract and wish to avail yourself of recently-created death benefit options, or if the performance of your subaccounts has been not been good. There are costs associated with exchanging annuities including potential surrender charges.
back to topCan I transfer between investment options easily?
You may transfer money among an annuity's investment portfolios as often as you like, subject to any prospectus limitations, without incurring any current income tax liability. Withdrawals of taxable amounts are subject to income tax and, prior to age 59½, may be subject to a 10% IRS penalty. A surrender charge may also apply.
back to topHow do "stepped-up" death benefits work?
If you die before receiving income from your annuity, the death benefit provides your beneficiary with a guaranteed benefit, one that does not have to go through probate. Some contracts offer optional "stepped-up" benefits which guarantee a minimum yearly percentage increase for your account and/or a minimum return on the value of your account. See the prospectus for detailed information on restrictions, limitations and fees for death benefit options. Death benefits are backed by the claims-paying ability of the issuing insurance company.
back to topWhat IRS reporting is required for annuity owners?
Unless withdrawals are made, or an annuitization option elected, there is no tax reporting on deferred annuities. At death, the value of the contract is included in the estate of the annuity owner. Any gains in the contract will be taxable to any beneficiary except surviving spouse.
A surviving spouse beneficiary may elect to continue the contract indefinitely, thereby postponing any current income tax liability. As with any investment, you should check with your tax or legal advisor regarding your personal situation.
back to topHow can I find out more about variable annuities?
Variable annuities are sold by prospectus only. Your Financial Advisor advisor can provide you with the prospectuses for the products in which you are interested. Investors should consider the objectives, risks, charges and expenses of the investment company. The prospectus contains this and other information. Please read the prospectus carefully before investing.
back to topMorgan Stanley Smith Barney LLC offers insurance products in conjunction with SBHU Life Agency, Inc. Citi Personal Wealth Management, MyFi, and Citi Private Bank offer insurance products in conjunction with Citigroup Life Agency LLC.
Please contact your advisor for more information about available products, services and research.
For more information, please contact your Financial Advisor.