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7.4 Annuities

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Series 65 Uniform Investment Adviser Law

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1 Introduction

About the Series 65 How to Use This Guide

2 Chapter 1: Economic Factors & Business Cycles

1.1 Business Cycles 1.2 Monetary Policy 1.3 Fiscal Policy 1.4 Inflation & Deflation 1.5 Interest Rates & Yield Curves 1.6 Global Economic Factors

3 Chapter 2: Financial Reporting & Analytical Methods

2.1 Financial Statements Overview 2.2 Accounting Fundamentals 2.3 SEC Filings & Annual Reports 2.4 Financial Ratios 2.5 Time Value of Money 2.6 IRR and NPV 2.7 Descriptive Statistics

4 Chapter 3: Types of Risk

3.1 Systematic (Market) Risk 3.2 Unsystematic (Company-Specific) Risk 3.3 Interest Rate & Reinvestment Risk 3.4 Inflation & Currency Risk 3.5 Liquidity Risk & Opportunity Cost 3.6 Risk Measurement & Portfolio Theory

5 Chapter 4: Cash Equivalents & Fixed Income Securities

4.1 Cash & Cash Equivalents 4.2 Treasury Securities 4.3 Agency Securities 4.4 Corporate Bonds 4.5 Municipal Bonds 4.6 Bond Pricing & Yields

6 Chapter 5: Equity Securities

5.1 Common Stock 5.2 Preferred Stock 5.3 Shareholder Rights & Corporate Actions 5.4 Equity Valuation Methods 5.5 ADRs, REITs & Other Equity Securities

7 Chapter 6: Pooled Investments

6.1 Mutual Funds 6.2 Mutual Fund Costs & Fees 6.3 Exchange-Traded Funds (ETFs) 6.4 Closed-End Funds & UITs 6.5 Hedge Funds & Private Equity

8 Chapter 7: Derivatives, Alternative Investments & Insurance Products

7.1 Options Basics 7.2 Options Strategies 7.3 Alternative Investments 7.4 Annuities 7.5 Life Insurance Products

9 Chapter 8: Client Types & Profiles

8.1 Individual Clients 8.2 Business Entity Clients 8.3 Trusts & Estates 8.4 Accredited & Qualified Investors 8.5 Suitability & Know Your Customer

10 Chapter 9: Portfolio Theory & Capital Markets

9.1 Modern Portfolio Theory 9.2 Capital Asset Pricing Model (CAPM) 9.3 Efficient Market Hypothesis 9.4 Risk & Performance Measures 9.5 Asset Allocation

11 Chapter 10: Portfolio Management Strategies

10.1 Investment Styles 10.2 Portfolio Management Techniques 10.3 Fixed Income Strategies 10.4 Return Calculations

12 Chapter 11: Tax Considerations & Retirement Planning

11.1 Capital Gains & Investment Taxes 11.2 Retirement Plans Overview 11.3 Individual Retirement Accounts (IRAs) 11.4 Education Savings Plans 11.5 Distributions & RMDs

13 Chapter 12: ERISA, Special Accounts & Performance Measures

12.1 ERISA Requirements 12.2 Special Account Types 12.3 Performance Measures & Reporting 12.4 QDROs & Special Situations

14 Chapter 13: Regulation of Investment Advisers

13.1 Investment Advisers Act of 1940 13.2 Registration Requirements 13.3 Recordkeeping Requirements 13.4 Custody Requirements 13.5 Exempt Reporting Advisers

15 Chapter 14: Regulation of Investment Adviser Representatives

14.1 IAR Definition & Requirements 14.2 Registration & Post-Registration 14.3 IARs of Federal Covered Advisers

16 Chapter 15: Regulation of Broker-Dealers & Agents

15.1 Broker-Dealer Definition 15.2 Agent Registration 15.3 Regulation Best Interest

17 Chapter 16: Securities Registration & Exemptions

16.1 Uniform Securities Act 16.2 Securities Registration Methods 16.3 Exempt Securities 16.4 Exempt Transactions

18 Chapter 17: Communications & Client Relationships

17.1 Advertising Rules 17.2 Social Media & Electronic Communications 17.3 Client Agreements & Disclosure 17.4 Proxy Voting & Other Obligations

19 Chapter 18: Ethics & Fiduciary Obligations

18.1 Fiduciary Duties 18.2 Prohibited Practices 18.3 Senior & Vulnerable Adult Protection 18.4 AML & Compliance Programs

7.4 Annuities

Key Takeaways Explain This Topic AI

Fixed annuities offer guaranteed returns and are not securities.

Variable annuities invest in subaccounts and are securities.

Variable annuities include subaccounts, separate accounts, and riders.

Fees include M&E, administrative charges, and subaccount expenses.

Earnings are taxed LIFO and early withdrawals face penalties.

1035 exchanges allow tax-free annuity swaps.

Last updated: December 2025

Annuities are insurance contracts designed to provide income, typically for retirement. They offer tax-deferred growth and various payout options. Investment advisers must understand the different types of annuities and their suitability for different clients.

What Is an Annuity?

An annuity is a contract between an individual and an insurance company. The individual pays premiums, and the insurance company promises to make periodic payments, either immediately or at a future date.

Two Phases of Annuities

  • Phase Description
  • Accumulation Phase Investor makes premium payments; assets grow tax-deferred
  • Annuitization Phase Investor receives periodic income payments

During accumulation, the investor owns accumulation units . At annuitization, these convert to annuity units , which determine the payment amount.

  • Types of Annuities
  • Fixed Annuities
  • Feature Detail
  • Returns Guaranteed interest rate set by insurer
  • Investment Risk Insurance company bears all risk
  • Regulation State insurance department only; NOT a security
  • Death Benefit Typically guaranteed principal
  • Suitable For Conservative investors; guaranteed income seekers
  • Variable Annuities
  • Feature Detail
  • Returns Based on performance of subaccounts (similar to mutual funds)
  • Investment Risk Investor bears the investment risk
  • Regulation SEC and FINRA regulated; IS a security
  • Death Benefit May fluctuate with account value
  • Suitable For Growth-oriented investors; higher risk tolerance
  • On the Exam

Variable annuities are securities because the investor bears the investment risk. They require a prospectus and are regulated by the SEC. Fixed annuities are NOT securities because the insurance company guarantees the return.

Equity-Indexed (Fixed-Indexed) Annuities

  • Feature Detail
  • Returns Linked to market index (S&P 500, etc.)
  • Participation Rate Limits upside (e.g., 80% of index gain)
  • Minimum Guarantee Floor on returns (often 0-3%)
  • Caps Maximum return per period
  • Regulation Generally NOT securities (state regulated)
  • Complexity Complex crediting formulas
  • Variable Annuity Features
  • Subaccounts

Variable annuity assets are invested in subaccounts , which are similar to mutual funds. The investor selects from various options:

  • Stock funds (growth, value, international)
  • Bond funds (government, corporate, high-yield)
  • Money market funds
  • Balanced/target-date funds
  • Separate Account

Variable annuity assets are held in a separate account —segregated from the insurance company's general account. This protects investors from the insurer's creditors.

Death Benefit

Most variable annuities guarantee a minimum death benefit :

  • At minimum: Return of premium paid
  • Stepped-up options: Higher of premium or account value at periodic intervals
  • Some offer enhanced death benefits (additional cost)
  • Living Benefit Riders

Optional riders provide guarantees during the investor's lifetime (for additional fees):

  • Rider Guarantee
  • GMIB (Guaranteed Minimum Income Benefit) Minimum income regardless of account value
  • GMWB (Guaranteed Minimum Withdrawal Benefit) Minimum annual withdrawal amount
  • GMAB (Guaranteed Minimum Accumulation Benefit) Minimum account value at specific date
  • Annuity Costs

Variable annuities have multiple fee layers:

  • Fee Type Typical Range Purpose
  • Mortality & Expense (M&E) 1.0% - 1.5% Insurance features and profit
  • Administrative Fees 0.10% - 0.30% Record-keeping, statements
  • Subaccount Expenses 0.25% - 2.0%+ Underlying fund management
  • Rider Fees 0.25% - 1.0% Optional benefit guarantees
  • Surrender Charges 7% declining to 0% Early withdrawal penalties
  • Surrender Charges

Most annuities impose surrender charges for early withdrawals:

  • Year Typical CDSC
  • 1 7%
  • 2 6%
  • 3 5%
  • 4 4%
  • 5 3%
  • 6 2%
  • 7 1%
  • 8+ 0%

Most contracts allow 10% free withdrawals annually without surrender charges.

Payout Options (Annuitization)

When the investor begins receiving income:

  • Option Description Risk
  • Life Only Payments for investor's lifetime; nothing to heirs Longevity risk for heirs
  • Life with Period Certain Payments for life OR minimum period (10, 20 years) Balanced
  • Joint and Survivor Payments continue for two lives Lower payments
  • Fixed Period Payments for set number of years May outlive payments
  • Lump Sum One-time payment No guaranteed income
  • In Practice

A retiree choosing between payout options must balance:

  • Life only : Highest payment, but heirs receive nothing if retiree dies early
  • Joint and survivor : Provides for spouse but lower monthly payments
  • Period certain : Guarantees minimum payments to heirs if death occurs early
  • Tax Treatment
  • Non-Qualified Annuities (After-Tax Contributions)
  • Event Tax Treatment
  • Contributions Not tax-deductible
  • Growth Tax-deferred
  • Withdrawals Earnings taxed as ordinary income (LIFO)
  • Before 59½ 10% early withdrawal penalty on earnings
  • Death Benefit Taxable income to beneficiary

LIFO (Last In, First Out) : Earnings are considered withdrawn first, so early withdrawals are fully taxable until all earnings are distributed.

Qualified Annuities (Pre-Tax Contributions)

Used in retirement plans (IRAs, 401(k)s):

  • Contributions may be tax-deductible
  • All withdrawals taxed as ordinary income
  • Subject to RMD rules after age 73
  • 1035 Exchange

Allows tax-free exchange from one annuity to another (or life insurance to annuity) without triggering taxable event.

Suitability Considerations

Variable annuities may be suitable for:

  • Long-term investors (10+ year horizon)
  • Those who have maxed out other retirement accounts
  • Investors seeking tax-deferred growth with upside potential
  • Those who want guaranteed income options

Variable annuities are NOT suitable for:

  • Short-term investors (surrender charges)
  • Those who need liquidity
  • Investors already in low tax brackets
  • Use in tax-deferred accounts (no additional tax benefit)
  • Young investors prioritizing growth over guarantees
  • On the Exam

Purchasing a variable annuity inside an IRA provides no additional tax benefit since IRAs are already tax-deferred. This is considered unsuitable unless other features (death benefit, living benefits) justify the cost.

  • Key Takeaways
  • Fixed annuities : Guaranteed returns; NOT securities; insurer bears risk
  • Variable annuities : Returns vary based on subaccounts; ARE securities; investor bears risk
  • Variable annuity features: Subaccounts, separate account, death benefit, living benefit riders
  • Costs include M&E, administrative fees, subaccount expenses, and surrender charges
  • LIFO taxation : Earnings withdrawn first, taxed as ordinary income
  • 10% penalty on withdrawals before age 59½ (on earnings)
  • 1035 exchange : Tax-free transfer between annuities

Loading diagram... Annuity Types