How Annuity Premiums Work and Compare to Other Premiums

Couple looking at their annuity insurance plan
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An annuity is an insurance product that can provide a stream of payments, tax-deferred earnings, or other features for long-term investors. But how do you get money into an annuity in the first place? You add funds in the form of “premiums.”

Annuity premiums are the funds that you pay into an annuity. Because annuities are insurance contracts, they use insurance terminology. Payments to other insurance contracts (such as auto or life insurance policies, for example) are also called premiums. While the lingo can be confusing, annuity premiums are often similar to account deposits.

How Different Types of Annuity Premiums Work

A premium paid into an annuity is simply an investment, in most cases.

Annuities are insurance company products, so any guarantees (such as lifetime income or earnings promises) are not government-guaranteed—they’re dependent on the insurance company’s financial strength and ability to pay.

Initial Investment

To start an annuity contract, you might make an up-front investment into the product. For example, you may want to buy an annuity with $10,000 of savings. To do so, you’d complete an annuity application and write a check for $10,000. That $10,000 would be your initial premium paid into the annuity contract.

Additional or Ongoing Premiums

You might also make additional payments into an annuity (assuming your contract and relevant tax laws allow you to do so). Depending on your insurance company and your preferences, you might be able to set up automatic monthly transfers via ACH. Alternatively, you might write a check or request an electronic transfer on-demand whenever you want to contribute more.

Single-Premium Strategy

Some people only make one annuity premium payment—or one investment—with a lump sum of money. After that, they just leave that initial investment alone and let the annuity do its thing for several years (or longer). It’s always important to monitor your investments on an ongoing basis, but you don’t necessarily need to add to an account if you don’t want to.

When you only make one payment into an annuity, the approach is often called a single-premium strategy. There are various products that make use of this strategy, including single-premium immediate annuities (SPIAs) and single-premium deferred annuities (SPDAs).

Account Transfers

You can also fund an annuity by transferring assets from another account, whether it’s an annuity or another type of account. If transferring from an annuity, pay close attention to the rules regarding like-kind exchanges.

It's often a good idea to enlist the help of a CPA, as annuity transfers can be fraught with pitfalls. When moving a significant amount of money, the consequences of any missteps can be severe.

Credit Cards

You typically do not make annuity deposits with a credit card. You might pay auto insurance (or other insurance) premiums on plastic, but annuities are different because your premium is essentially a sort of investment. If using a credit card, you would effectively be borrowing to invest, which is generally a risky strategy.

Dollar Limits

Check with your insurance company to see if there are any minimum or maximum limits on premiums. If your annuity is also an individual retirement account (IRA) or any other account subject to annual limits, be mindful of IRS rules on how much you can contribute each year.

The Long-Term Commitment of an Annuity Premium

Before you contribute funds to an annuity, make sure you understand that you might be locking your money up for the long term. There may be consequences, for instance:

  • If you pull those funds out before the annuity's surrender period ends, you might have to pay penalty charges to the insurance company.
  • You might face tax consequences for removing funds from an annuity, including income taxes, additional penalty taxes, and the need to pay estimated taxes.

How Premiums Compare to Other Insurance Premiums

For some annuities, you're not required to continually make premium payments as you do with standard life insurance or auto insurance contracts. Of course, you should verify exactly what is required in your particular situation and with your specific contract—failing to meet those requirements could forfeit any rights or benefits you've earned.

Also, the more you contribute, the more you're likely to have later, so it might be helpful to add to any existing savings (assuming the annuity contract is the right place for those additional savings—which you should continually reevaluate). If you need help, discuss your needs and your options with a Certified Financial Planner and a tax professional who is familiar with annuity issues.