How an annuity works
Most annuities have two phases. During the accumulation phase, your money earns interest according to the contract and grows tax deferred. During the payout phase, the insurer makes income payments. The NAIC's buyer's guide explains that some annuities begin paying income soon after you buy them (an immediate annuity), while others begin at a later date you choose (a deferred annuity) (NAIC Buyer's Guide for Fixed Deferred Annuities).
When income starts, you choose a payout option. The NAIC lists common choices: for your lifetime; for the longer of your lifetime or your spouse's; for a set period; or for the longer of your lifetime or a set period. Turning a deferred annuity into a stream of payments is called annuitizing, and FINRA notes the decision is generally irrevocable (FINRA: Annuities).
Deferred annuities also generally include a basic death benefit during accumulation, paid to your beneficiaries. After income starts, whether anything passes to survivors depends on the payout option you chose. Our article on annuity beneficiary rules goes into this.
The main types of annuities
Fixed annuity
The insurer sets an interest rate for a period, then sets a renewal rate that may be higher or lower. Fixed deferred annuities include a guaranteed minimum interest rate stated in the contract (NAIC). There is no direct market exposure. See our fixed annuity page.
Multi-year guaranteed annuity (MYGA)
A type of fixed annuity where the declared rate is locked for a set number of years, often matched to the surrender period. People sometimes compare MYGAs with bank CDs; they are different products with different protections and liquidity. See our MYGA page and MYGA vs. CD comparison.
Fixed indexed annuity
Interest is credited based partly on changes in a market index, such as the S&P 500, using a formula. The NAIC explains that participation rates, cap rates and spread rates mean credited interest may not reflect the full index change, and that if the index goes down over the period, zero interest is added and the value does not go down as long as you do not withdraw money. You are not investing directly in the market. Fees, riders and withdrawals can still reduce value. See our fixed indexed annuity page.
Immediate income annuity
You pay a single premium and income begins right away or soon after. Investor.gov notes income payments typically start within one year of purchase. It trades a lump sum for a stream of payments. See our immediate income annuity page.
Variable annuities and RILAs
Variable annuities and registered index-linked annuities (RILAs) are both insurance products and securities, regulated by state insurance regulators and registered with the SEC, and the people who sell them must be registered with FINRA (Investor.gov; FINRA). They can lose value. Big Sioux Life does not offer these; if someone recommends one, you can check the seller on FINRA BrokerCheck.
Surrender charges, fees and access to your money
Annuities are built for the long term, and the contract limits early access.
- Surrender charge: a charge, as a percentage of the amount withdrawn, if you take out more than allowed during the surrender period. The NAIC notes the percentage usually goes down each year until the period ends.
- Annual withdrawal allowance: most annuities with surrender charges let you take out a certain amount, usually up to 10% a year, without a surrender charge on that amount (NAIC). Check your contract.
- Market value adjustment (MVA): some contracts adjust withdrawals up or down depending on how interest rates have moved since purchase.
- Fees and riders: contract fees, premium taxes in some states, transaction fees, and optional riders such as income or enhanced death benefits usually cost extra.
Investor.gov reminds buyers that taking the contract's value as a lump sum "may subject you to surrender charges, taxes, and tax penalties." Our article on annuity surrender charges walks through how a schedule works.
How annuities are generally taxed
Earnings inside an annuity are tax deferred: you generally do not pay income tax on interest until you take it out. The NAIC stresses that this "isn't the same as tax-free." Withdrawals and income payments of earnings are taxed as ordinary income, and beneficiaries typically owe income tax on the gain in a death benefit.
Withdrawals before age 59½ may be subject to an additional 10% federal tax unless an exception applies, such as death or disability (IRS Topic 410, Pensions and annuities). Annuities held inside an IRA follow IRA rules, and the NAIC notes you get the same tax deferral in an IRA whether or not you use an annuity to fund it.
Tax rules depend on whether the annuity is qualified (inside a retirement plan or IRA) or non-qualified, and on your situation. We are not tax advisors; please confirm with a tax professional. Our annuity taxation article and QLAC and RMD article cover common questions.
What "guaranteed" means in an annuity
Annuity guarantees, such as a minimum interest rate or lifetime income, are promises made by the insurance company, not by a government agency. The NAIC says all product guarantees depend on the insurer's financial strength and claims-paying ability, and Investor.gov adds that if the insurer has financial difficulties, "it may not be able to pay you." FINRA notes annuities are not guaranteed by the FDIC, SIPC or any other federal agency.
That is why checking the insurer matters. The NAIC suggests reviewing ratings from independent rating agencies and contacting your state insurance department. In South Dakota, the Division of Insurance lists companies licensed to sell insurance in the state.
Protections when you buy an annuity in South Dakota
South Dakota has adopted an annuity best-interest standard of conduct for agents and insurers. According to the Division of Insurance's page on Annuity Best Interest Standards, a producer making a recommendation must satisfy four obligations: care, disclosure, conflict of interest and documentation. In practice that means the agent must know your financial situation, insurance needs and objectives; have a reasonable basis to believe the recommendation addresses them; explain the basis for it; disclose their role, compensation and material conflicts; and document the recommendation in writing. The Division requires an "Insurance Agent (Producer) Disclosure for Annuities" form before a recommendation or sale.
The NAIC adds two more consumer protections to know about:
- Free look: in many states, a law gives you a set number of days, usually 10 to 30, to change your mind after you receive the annuity. Your contract should state the period prominently.
- Licensing: an annuity salesperson must be licensed by your state insurance department. Check an agent with the Division's license look-up.
For more on the standard, see our article on South Dakota's annuity standard. Complaints can go to the Division of Insurance.
Questions to ask before you buy
These are adapted from the questions in the NAIC buyer's guide:
- Do I understand the risks, and am I comfortable with them?
- How does this annuity fit my overall goals and time horizon?
- What features, other than tax deferral, make it appropriate for me?
- How long is the surrender period, what are the charges each year, and how much can I take out without a charge?
- Which values are guaranteed, for how long, and which can change?
- What fees and rider costs apply?
- If I am replacing an existing annuity, what will I give up, and does a new surrender period start? FINRA notes exchanges can add costs and restart surrender charges.
- How is the agent paid for this sale?
If an annuity does not seem right for you, or you do not understand it, you do not have to buy it. Our article on making retirement savings last looks at where annuities can fit in a broader plan.
How Big Sioux Life can help
We work with fixed, fixed indexed, immediate income and multi-year guaranteed annuities from the carriers we represent, and we explain surrender schedules, crediting methods and payout options before you decide. We are licensed insurance agents, not tax or investment advisors, and we follow South Dakota's annuity standard of conduct. Rates, caps and features vary by carrier and change often, so we do not publish them here. Start with our annuities overview.