An annuity is a contract between an investor and an insurance company typically used to provide retirement income.  Investors buy an annuity by making a single large payment or a series of payments over time called premiums to the insurance Annuitycompany.  As the payments are made to the insurance company the account value of the annuity will grow at different rates depending on the type of annuity purchased (fixed, variable, indexed; see our next post for details about the different types of annuities).  In exchange for the premiums collected now the insurance company promises to make a series of payments to the investor (also called the annuitant) for the rest of the investor’s life.  These payments may start immediately or at some future time.

In an immediate annuity, the investor begins receiving payments from the insurance company immediately after buying the annuity.  For example, a 65 year old man might purchase an immediate annuity with $100,000 and could immediately start receiving $500 per month until death.  A deferred annuity, on the other hand, will delay the payments from the insurance company until the investor chooses to start receiving them.  For example, a 35 year old man might invest $100 per month for the next 30 years growing the account value.  Once the man reached retirement age, he could then choose to begin receiving payments from the insurance company, based on both the amount invested and the growth of those assets in the annuity.

The amount the investor will receive upon annuitization (the conversion of the accumulated contract value of the annuity  into a stream of periodic payments) depends on a variety of factors, including:

1. Account value – determined by the amount contributed and the rate of return achieved
(depending on the annuity product, this could be fixed, variable, or indexed)
2. Age and gender of the investor
3. Payout option (straight life, life with period certain, joint and last survivor)

Once annuitized the investor is entitled to the stream of periodic payments, and does not have access to the account value. Additional benefits, such as the guaranteed death benefit may also end. One way to think about annuitization is that the investor is turning over the total account value (e.g. $100,000) to the insurance company in exchange for a promise of payments for the rest of the investor’s life.  At this point the $100,000 belongs to the insurance company, and once the investor dies the payments stop.

Knopman Notes
Candidates for the exam should be familiar with both the general characteristics of the various annuity products: fixed, variable, indexed; and the payouts options available to annuity investors: straight life; life with a period certain, joint & last survivor.  Equally important is to understand the reasons investors should purchase these products.  In general, the annuity product helps investors save for retirement and ensuring that investors do not outlive their retirement savings (nest egg).  Annuities do this because they  provide a stream of income for as long as the annuitant lives.

The other important aspect for candidates to understand is the fees and expenses associated with annuity products.  These can be higher than a typical brokerage account, and annuities also carry surrender charges.  A surrender charge is assessed upon the early withdrawal or cancellation of the annuity.  In short, it is a fee to liquidate or cash out an annuity product should the investor no longer wish to own the annuity.

Relevant Exams
Series 7, Series 24, Series 65, Series 66

Written by Dave Meshkov
Dave's mission (and job: Managing Director of Course Design) is to make FINRA exam training engaging, approachable, and dare he even say, enjoyable. Having trained and coached over ten thousand students to exam success he knows how to present complex subjects in memorable and understandable ways. Prior to joining Knopman Marks in 2011, Dave practiced bankruptcy law at Weil, Gotshal & Manages and served as a law clerk in a the Southern District of New York Bankruptcy Court working on the General Motors and Lehman Brothers bankruptcies. Building on his legal expertise and training allows him to keep all our courses updated with the latest legislative and rule-making changes. Dave currently trains for the Securities Industry Essentials (SIE) exam and the Top-Off Series 6, 7, 24, 57, 63, 65, 66, 79, 86, 87, and 99 exams. He also delivers executive one-on-one training and shares his passion for learning outside of work as a ski instructor and yoga teacher. Dave graduated magna cum laude from Fordham Law School, and cum laude with a BA from the University of Pennsylvania.