What is an annuity?

  A right to receive fixed, periodic payments, either for life or for a term of years.  

Black’s Law Dictionary

Johann Gutenberg, inventor of the printing press, received an annuity, for a time, from the city of Mainz.

The largest annuity system today is the Social Security monthly retirement benefits system. (

Generally, most annuities today are issued by insurance companies.

  An annuity is a contract with an insurance company. With an annuity, the insurance company promises to pay you income on a regular basis for a period of time you choose -including the rest of your life. 

National Association of Insurance commissioners -Buyers Guide for Deferred Annuities

Key takeaway: an annuity is a contractual agreement between you and an insurance company. The insurance company promises you X if you abide by Y.

There are Two General Uses of Annuities

  • Accumulation of savings for future use
    • Period payment made over time, or
    • Lump sum deposits
  • Generating guaranteed retirement income
    • For a set period, or for life
    • Single life payments or joint life payments

The Basic Types of Annuities:

  • Guaranteed annuity: provides a fixed return with no downside market risk.
  • Fixed indexed annuity: links your money to a specific market index such as the S&P 500 Index.
  • Variable annuities: include sub-accounts that operate like mutual funds and include market risk.
  • Registered index linked annuities: links your money to a specific market index such as the S&P 500 Index.

**Each type of annuity has various features and options to choose from.

Commissioned Annuities Vs. Fee-Based Annuities

Annuities have traditionally been sold by insurance agents who were paid an upfront commission for the annuity sale.

Variable annuities added a twist, in such that advisors selling these products not only had to have an insurance license but also a Series 6 securities license, as variable annuities were deemed a security.

Commissioned Based Annuities

The agent is typically paid a large, one-time up-front commission from the insurance company. The purchaser of the annuity has a surrender charge that makes it difficult to move out of the annuity without incurring a fee. It is common to see a surrender charge that is 10-years long. An example is as follows:


Other annuity contracts exist with very long surrender charges, such as an 18-year surrender charge period. However, be careful and do your due diligence. It is unwise to purchase one of these products. Confirm the surrender schedule is what your contract states.

Commission based variable annuities are known to have very high expenses. Be sure to do your homework.

Fee-Based Annuities

Fee-based annuities are a newer version of annuities that are designed for the fee-based, fiduciary advisor.

Fee-based advisors have to comply with either Securities and Exchange Commission (SEC) or State Securities Department rules and guidelines.

The advisor adds their advisory fee to the annuity just as they do with any other investment account they would manage on your behalf.

Benefits of a fee-based annuity are:

  • Low cost
  • One-year contracts are available.
  • Limited or no long, back-end surrender charge.
  • Your advisor is more engaged, since they are earning a consistent fee for managing your account.

At Kompass Financial Advisors, as fiduciary advisors, we mostly use fee-based annuities, but there are situations where a commission-based annuity may be the more attractive option.

Insurance Company Soundness

The size and financial ratings of the company are critical for their ability to deliver on their contractual obligations to their annuity contract holders.

Financial ratings examples are as follows:

AM Best: A++, A+, A, A-, B++, B+
Standard & Poor: AAA, AA+, AA, AA-, A+, A-
Moody’s: Aaa, Aa1, Aa2, Aa3, A1, A2, A3
Fitch: AAA, AA+, AA, AA-, A+, A, A-
COMDEX Rating, a composite of the above stated as a percentile against all companies.

Our goal is to use insurance companies that have a COMDEX rating in the 90th percentile of all insurance companies.

Do not simply take an insurance agent’s word that the company has good ratings. Understand the ratings system and obtain the ratings of each company you are considering. Do your due diligence, and of course, we can help you.

Taxation of Annuities

Qualified Annuities:

  • If you purchase an annuity inside a Traditional IRA, or within your employer’s retirement plan, then it is considered a “Qualified Annuity”.
  • Taxation is deferred until you take distributions, at which time you will owe state and federal tax on the full amount distributed.
  • If you are under age 59 ½, you will also owe a 10% early withdrawal penalty.

Non-Qualified Annuities:

  • Here you take money that is not part of a Qualified Plan and invest it into an annuity contract.
  • Taxes on the growth of the annuity are deferred while inside the annuity contract.
  • Once you begin to take money out of the annuity contract, state and federal taxes will be owed on the growth you experienced inside the annuity.
  • The taxation calculation differs between taking a lump sum distribution or periodic payments.

**Always consult with a tax professional regarding the tax implication of purchasing an annuity and taking future distributions.

As fiduciary advisors, it is our duty to help you review the different annuity options available and then determine if any of those options help you meet your goals and objectives.

Do not hesitate to give us a call for help.


Kompass Financial Advisors

6500 S. Quebec St., #300
Englewood, CO 80111

PO Box 67
Wauneta, NE 69045

 Toll Free: (888) 770-0004

 (303) 770-7078

  [email protected]