Other Types of Annuities

Two-tiered annuities

An annuity may be taken, or annuitized, by the annuitant in periodic payments or as cash in a lump sum amount. If taken in this latter form, the total payout amount will be different than if the annuity had been paid out in installments under one or another of the usual annuity settlement options. Therefore, a two-tiered annuity is one that has different values available for distribution at maturity depending upon whether the benefit is taken by the annuitant as a lump sum or left with the issuer to make periodic payments.

Two-tiered annuities offer relatively high rates, but only if the owner holds the contract for a certain number of years before annuitizing it. If the annuity is surrendered at any point, interest credited to the contract is recalculated from the contract's inception using a lower tier of rates. While the higher tier of rates is designed to reward annuitization and make the product more appealing than competing annuities, the lower tier generally makes the contract somewhat unattractive compared to other alternatives. Further, some contracts apply this interest penalty even if the annuity is surrendered due to the death of the owner.

Some states do not permit sales of two-tiered annuities because of the potential for misunderstanding on the part of consumers or a lack of adequate disclosure on the part of agents regarding the conditions that must be met in order for the owner to earn the higher tier of interest rates. Therefore, agents who sell two-tiered annuities must make sure that their purchasers know how the product works and are prepared to commit themselves and their beneficiaries to the annuity for the long term.

Tax-sheltered annuities

Public school systems and tax-exempt charitable, educational, and religious organizations are often encouraged to set aside funds for their employees' retirements by the use of tax-sheltered annuity plans (or TSAs). Once the program is set up, employee contributions to the plan are excluded from their current taxable income. The plan must be established by the employer and contributions must be used to purchase annuity contracts or mutual fund shares.

Payments received from TSAs at retirement are generally fully taxable to the recipient as ordinary income. However, because taxable income at retirement is usually less and the fact that the TSA payments may be spread over a long period of time, the recipient's overall tax bracket can be expected to be lower.

Retirement income annuities

A retirement income annuity is an ordinary deferred annuity that includes an additional feature – a decreasing term life insurance rider that provides term life insurance with a face amount that decreases each year the policy is in force. The effect is that if the annuitant reaches retirement age (say 65, for example), the decreasing term insurance death benefit expires and annuity payments begin providing retirement income. If, on the other hand, the annuitant dies before retirement, the decreasing term insurance death benefit is combined with the current value of the annuity and paid to the annuitant's beneficiary in any settlement option chosen.

Equity-indexed annuities

Equity-indexed annuities are generally considered to be fixed annuities because they offer both a guaranteed minimum interest rate and a guarantee against loss of principal if held to term (as with other fixed annuities, surrender charges may reduce the principal amount if the policy is surrendered early). However, with an equity-indexed annuity, any interest credited that is in excess of the minimum guaranteed rate is linked to the upward movement of a designated equity index, such as the Standard and Poor's 500 Stock Index, for example. If the index moves upward, the interest rate is based on some portion of the increase. If the index moves downward, the contract guarantee provides for at least the guaranteed minimum rate.

As an example, let's assume that Mr. Jones has an equity-indexed annuity with a guaranteed minimum interest rate of 6% and is linked to the Standard and Poor's 500 index. If the index should go up, Mr. Jones can expect his annuity interest rate to correspondingly go up as well. But if the index should go down, the lowest annuity interest rate that Mr. Jones can expect to receive would be 6%, the contract's guaranteed minimum.

Market-value adjusted annuities

Like the equity-indexed annuity, the market-value adjusted (MVA) annuity is also a fixed annuity product with a market-driven feature. However, instead of having the annuity's interest rate linked to an index, the MVA annuity's interest rate remains fixed. The market-value adjustment feature only applies if the contract is surrendered before the contract period expires. As such, an MVA annuity must disclose on the first page of the document that the non-forfeiture values may increase or decrease based on the market value formula specified in the contract. Otherwise, the annuity functions in the same manner that a fixed annuity does.

If an MVA annuity owner decides to surrender his or her contract early, a surrender charge and a market value adjustment will apply. If interest rates decreased during the contract period, the market value adjustment will be positive and may add to the surrender value of the contract. However, if interest rates increased during the time the contract was owned, the market value adjustment will be negative, which would increase the contract's surrender charge.

Let's take a look at this example. Suppose Ms. Smith owns a 10-year MVA annuity contract but decides to cash it in after the sixth year. By cashing it in early, she would be automatically subject to a surrender charge, and because interest rates rose by 2% since she the time that she purchased the contract, her market-value adjustment would be negative, forcing her to pay an even higher surrender charge.

Depending on whether the MVA annuity is registered, the market value adjustment may only apply to interest earned under the contract. However, if the MVA annuity is registered, both principal and interest will be susceptible to a market value adjustment. Since MVA annuities expose consumers to investment risk, they're classified as securities and the agents who sell them must be registered with the Financial Industry Regulatory Authority (FINRA), formerly known as the National Association of Securities Dealers (NASD).