What Is a Combination Annuity and How Does It Work?

A combination annuity blends features of both fixed and variable annuities, offering stability and growth potential. Often used for retirement planning, it provides income while balancing risk and reward. Investors can customize their contract based on premiums, return structures, and payout schedules.

Contract Elements

A combination annuity includes customizable components that determine how contributions grow and payouts are structured. Each contract specifies how premiums are paid, how returns accumulate, and when distributions occur. These factors influence both risk and potential earnings, making it essential for policyholders to evaluate their options carefully.

Premium Options

Premiums affect an annuity’s growth and accessibility. Some contracts require a single lump-sum payment, while others allow multiple contributions over time. A single premium option suits those with a large sum available, such as proceeds from a retirement account rollover. Flexible premiums enable periodic payments, useful for individuals still in their earning years.

Insurers set minimum contribution requirements, which can range from a few thousand dollars to significantly higher amounts. Some contracts allow automatic deductions from a bank account or payroll, ensuring consistent contributions. The timing of payments also affects growth, as earlier contributions benefit more from compounding. Understanding these options helps investors align their annuity with financial goals.

Return Structures

Returns depend on the allocation between fixed and variable components. The fixed portion provides a guaranteed interest rate, ensuring baseline income regardless of market conditions. Rates vary based on prevailing interest rates and the insurer’s financial stability.

The variable portion is tied to investment choices, such as subaccounts tracking stocks, bonds, or other assets. Returns fluctuate with market performance, offering higher earning potential but increased risk. Some annuities include a “floor” to limit losses, while others cap gains. Policyholders can adjust their allocation between fixed and variable accounts over time, adapting to market conditions or changes in risk tolerance.

Payout Schedules

Distributions affect both income duration and total amount received. Some contracts offer immediate payouts, beginning shortly after funding, which suits retirees needing income right away. Deferred payouts allow the annuity to grow before withdrawals begin.

Payout periods vary. Some contracts provide payments for a fixed number of years, while others offer lifetime income. Joint annuities extend payments to a surviving spouse. Some contracts include cost-of-living adjustments to counter inflation. Selecting a payout schedule requires balancing immediate financial needs with long-term income security.

Tax Considerations

Tax treatment depends on how the annuity is funded and when distributions begin. If purchased with pre-tax dollars, such as through a traditional IRA or 401(k) rollover, taxes are deferred until withdrawals, at which point they are taxed as ordinary income. If funded with after-tax dollars, only the earnings portion of withdrawals is taxable.

The IRS uses an exclusion ratio to determine the taxable portion of each payout for after-tax-funded annuities. Once the full initial investment has been recovered, all remaining distributions become fully taxable.

Tax-deferred growth allows earnings to accumulate without immediate tax consequences, enabling more efficient compounding than taxable accounts. However, large withdrawals can push policyholders into higher tax brackets. Spreading withdrawals over multiple years helps manage tax liability.

Withdrawal Provisions

Accessing funds involves specific rules affecting timing and cost. Most contracts include a surrender period, typically five to ten years, during which withdrawals incur a penalty. Surrender charges often start around 7% and decrease annually. Some policies allow penalty-free withdrawals up to a certain percentage of the account value, often around 10% annually.

After the surrender period, withdrawals are penalty-free but still subject to tax implications. If the annuitant is under age 59½, the IRS imposes a 10% early withdrawal penalty on taxable portions. Some contracts waive surrender charges for terminal illness, long-term care needs, or disability, though eligibility varies by insurer.

Optional Add-Ons

Many combination annuities offer riders that enhance benefits. A guaranteed lifetime withdrawal benefit (GLWB) ensures a minimum income level regardless of market fluctuations, preventing premature fund depletion. The insurer calculates this amount based on factors such as age at first withdrawal and account value, with higher payouts for delayed withdrawals.

Some contracts include a death benefit rider, guaranteeing a minimum payout to beneficiaries. This can be structured as a return of premium, ensuring heirs receive at least the total contributions made, or as an enhanced death benefit that accounts for potential investment gains. These riders provide financial security but often come with additional fees.

Regulatory Factors

Combination annuities are regulated by state insurance departments and federal agencies. State regulators establish rules for disclosure requirements, reserve mandates, and licensing standards, ensuring policyholders receive clear information about fees and risks. State guaranty associations offer limited protection if an insurer becomes insolvent.

On the federal level, annuities with variable components fall under the jurisdiction of the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). These agencies enforce investment disclosures, suitability requirements, and sales practices. Agents selling variable annuities must hold securities licenses and adhere to fiduciary standards. The IRS also imposes tax regulations, particularly required minimum distributions (RMDs) for annuities held within retirement accounts. Understanding these regulations helps investors assess insurer reliability and legal protections.