Annuity Basics
Annuities are insurance contracts designed to provide retirement income. They offer tax-deferred growth and various payout options to help investors manage longevity risk—the risk of outliving one's savings.
Why Annuities Matter for Series 7
Because variable annuities are securities, they represent a significant portion of the Series 7 exam. You must understand:
- The difference between fixed and variable annuities
- Accumulation and annuity phases
- Tax treatment and penalties
- Suitability considerations
Fixed vs. Variable Annuities
| Feature | Fixed Annuity | Variable Annuity |
|---|---|---|
| Investment account | General account | Separate account |
| Returns | Guaranteed rate | Based on subaccount performance |
| Investment risk | Insurance company | Policyholder |
| Payout amount | Fixed | Variable |
| Securities registration | Not a security | Registered as security |
| Regulation | State insurance | SEC, FINRA, and state insurance |
Fixed Annuities
- Money deposited in insurer's general account
- Insurance company guarantees a minimum interest rate
- Not considered securities (exempt from SEC registration)
- Regulated by state insurance departments only
- Protect against market risk but not inflation risk
Variable Annuities
- Money invested in separate account (like mutual fund subaccounts)
- Returns depend on investment performance
- Policyholder bears investment risk
- Designed to hedge against inflation
- Registered as securities with SEC
- Require Series 6 or Series 7 license PLUS state insurance license to sell
Immediate vs. Deferred Annuities
| Feature | Immediate Annuity | Deferred Annuity |
|---|---|---|
| Premium payment | Single lump sum | Single or periodic |
| Payout begins | Within 12 months | Future date (years later) |
| Accumulation phase | None | Yes |
| Purpose | Immediate income need | Retirement savings |
Immediate Annuities
- Purchased with a single lump-sum payment
- Payments begin within 30 days to 1 year
- No accumulation phase
- Converts immediately to income stream
- Used when income is needed right away
Deferred Annuities
- Payments begin at a future date
- Has an accumulation phase for growth
- Tax-deferred growth during accumulation
- Can be funded with single premium or periodic payments
- Used for retirement planning
The Two Phases of Annuities
1. Accumulation Phase (Pay-In)
During this phase:
- Owner makes premium payments
- Value grows tax-deferred
- Variable annuity owners purchase accumulation units
- No income is received yet
2. Annuity Phase (Payout)
During this phase:
- Accumulation units convert to annuity units
- Owner receives periodic income payments
- Taxable portion is taxed as ordinary income
- Once annuitized, typically cannot be reversed
Important: Key Distinction Fixed annuities are NOT securities (general account, guaranteed returns). Variable annuities ARE securities (separate account, market-based returns). Most Series 7 questions focus on variable annuities.
Up Next
6.2 Variable Annuities
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