5.2 Accumulation (Pay-In) Period
The accumulation period is the time from the initial premium payment until a settlement option is selected. During this period, funds grow on a tax-deferred basis. The accumulation period exists only in deferred annuities, as immediate annuities begin making payments shortly after the premium is paid and therefore do not have an accumulation phase.
Premium Payment Options
Single Premium: A single lump-sum payment is made into the annuity contract at the time of purchase.
Periodic Premium: Premiums are paid into the annuity on a continuing basis over time. A common form of periodic premium funding is the flexible premium structure.
Flexible Premium: Contributions may be made at various times and in varying amounts according to the contract owner's preference. However, insurers typically establish minimum and maximum contribution limits that must be followed.
Immediate and Deferred Annuities
Immediate Annuity: An immediate annuity begins making income payments shortly after purchase, typically within one year of the issue date. Because payments begin quickly, immediate annuities do not include an accumulation period.
Deferred Annuity: A deferred annuity provides income payments that begin at a future date, usually more than one year after the contract is issued. During the time before payments begin, the annuity accumulates value in the accumulation phase.
| Annuity Mechanics | |
|---|---|
| Single Premium Immediate Annuity (SPIA) | A single premium (lump sum) is put into an annuity from which the annuitant may immediately begin drawing benefits (within a year of the issue date). A retirement plan rollover, savings account balances or CDs, mutual funds, deferred annuity values, or the death proceeds of a life insurance policy might be used to purchase a SPIA. |
| Single Premium Deferred Annuity (SPDA) | A single premium (lump sum) is put into an annuity from which the annuitant will draw the benefits at some specified time in the future, more than 1 year from the issue date. |
| Flexible Premium Deferred Annuity (FPDA) | Flexible contributions may be made as often and in whatever amount the contract owner desires. However, most insurers set a minimum and a maximum amount for contributions. Benefits begin more than 1 year from the issue date. |
Deferred Annuity Characteristics
Deferred annuities are commonly used to defer taxation on earnings within the contract, making them well suited for accumulating funds for retirement. During the accumulation period, only the contract owner has the authority to authorize the surrender of the annuity. In the early years of the accumulation phase, the insurer typically imposes a surrender charge if the contract is terminated.
- Tax-Deferred Growth: Because an annuity is an insurance contract, the accumulation value grows on a tax-deferred basis. Deferred annuities also allow the owner to designate a beneficiary who will receive the contract value if the annuitant dies before the annuity is annuitized. Withdrawals made before age 59½ are generally subject to income tax and may also incur a 10% early withdrawal penalty. In addition, systematic withdrawals may be used to access the annuity's value without formally electing a settlement option.
Nonforfeiture Provisions
An annuity owner does not lose the value that has accumulated in the contract if contributions stop. Nonforfeiture provisions protect the owner's right to the accumulated value within the annuity. The owner may also choose to surrender the contract during the accumulation period and receive the available value, subject to any applicable surrender charges. These provisions apply only to deferred annuities, since immediate annuities do not have an accumulation period.
Tax Penalty: To discourage the use of annuities as short-term tax shelters, a 10% tax penalty is generally imposed on withdrawals made before the contract owner reaches age 59½. This rule is intended to discourage early withdrawals from the annuity. The penalty does not apply if the early distribution occurs because of the death or disability of the contract owner.
Surrender Charges: When an annuity contract is fully surrendered, any applicable surrender charges reduce the amount paid to the contract owner. These charges are often referred to as a back-end load. Surrender charges typically decline over a specified number of years according to a schedule established by the insurer and eventually disappear once the surrender period ends.
Bailout Provision (Escape Clause): During the accumulation period, some annuity contracts include a bailout provision that allows the owner to withdraw funds without incurring surrender charges if the credited interest rate falls below a specified level. This provision provides the contract owner with the flexibility to move funds to other savings or investment alternatives if the annuity's credited rate declines significantly.
Waiver: Surrender charges on an annuity may be waived under certain circumstances, such as when the annuitant is hospitalized for an extended period, admitted to a nursing facility for at least 30 days, becomes disabled, or dies.
Quiz
1. What is the accumulation period in an annuity contract?
A. The period when annuity payments are distributed to the annuitant
B. The period from the first premium payment until a settlement option is selected
C. The time when the beneficiary receives death benefits
D. The time after the annuitant dies
Correct Answer: B
Rationale: The accumulation period is the phase during which funds are paid into the annuity and grow on a tax-deferred basis. It lasts from the initial premium payment until the owner selects a settlement option or annuitization begins.
2. Which type of annuity begins making income payments within one year of the issue date?
A. Deferred Annuity
B. Flexible Premium Deferred Annuity
C. Immediate Annuity
D. Variable Annuity
Correct Answer: C
Rationale: An immediate annuity starts paying income shortly after purchase—typically within one year. Because payments begin quickly, immediate annuities do not have an accumulation period.
3. Which premium payment option allows the contract owner to make contributions at varying times and amounts?
A. Single Premium
B. Fixed Premium
C. Flexible Premium
D. Level Premium
Correct Answer: C
Rationale: A flexible premium annuity allows the owner to contribute funds at different times and in varying amounts, subject to minimum and maximum limits established by the insurer.
4. What tax consequence generally applies if an annuity owner withdraws funds before age 59½?
A. No taxes apply
B. Only capital gains tax applies
C. A 10% early withdrawal penalty may apply in addition to income tax
D. The entire annuity becomes tax free
Correct Answer: C
Rationale: Withdrawals made before age 59½ are generally subject to ordinary income tax on the earnings portion and may also incur a 10% early withdrawal penalty, unless an exception such as death or disability applies.
5. What is the purpose of surrender charges in a deferred annuity?
A. To increase the annuity's interest rate
B. To discourage early withdrawals and help the insurer recover costs
C. To guarantee lifetime income
D. To eliminate tax penalties
Correct Answer: B
Rationale: Surrender charges, often called back-end loads, reduce the payout if the annuity is surrendered during the early years of the contract. They are designed to discourage early withdrawals and allow the insurer to recover administrative and sales costs.