How Products and Practices Evolved
So, using all of the above as a backdrop, let’s examine how our present day annuities and sales practices have evolved as a result of tax.

Withdrawals
Withdrawals from annuities are taxed in one of two ways depending upon when the annuity was issued.

Past
Annuities issued prior to 8-14-82, had FIFO accounting (first in, first out). Since principal was first in, it came out first, income tax free. Earnings came out last.

Present
With annuities issued on 8-14-82 and thereafter, taxation changed to LIFO (last in, first out). Simply put, withdrawals are now taxable since earnings are withdrawn first.

Evolution Effect (Good and Bad)
Annuities with longer surrender charges appeared which did, among other things, reinforce that an annuity is a long-term retirement product. Some annuities appeared with lower or no free withdrawal provisions since earnings now came out first.

Since sales continued to climb in spite of lessened tax-advantages, more insurers with household names entered the annuity arena. As a result, small, medium, and large companies began designing innovative annuities with special features, benefits, and interest rates so varied that annuity spreadsheets surfaced for the first time. Competition increased at the point of sale and annuity illustrations often calculated by hand using a calculator in the early 1980’s were replaced by computer generated illustrations.

Exclusion Ratio
When and if the owner annuitizes (applies their annuity value toward a settlement option), the annuitant can receive equal payments. How will the owner pay taxes on the payments? Will they be fully taxable like withdrawals? No. An exclusion ratio is applied to each payment received. What is an exclusion ratio? A percentage of each payment is considered a return of the owner's cost basis and is tax-free. The balance is taxable.

Present
Effective with all annuity starting dates after 12-31-86, payments become fully taxable after the owner recovers the total of all premiums paid into contract (determined by adding all dollars excluded from taxes). In other words, after they have lived beyond their expectancy (as calculated when payments began), payments then become fully taxable.

Evolution Effect
Unquestionably, when you combine a) the aging of America statistical data. b) an annuity being the only product in the financial market that can guarantee income for someone for as long as they live and c) with the current taxation of immediate annuities described briefly above, you can appreciate why immediate annuity sales have doubled over the last 5 years.

And, when you witness the products, riders, benefits, and practices that have recently surfaced (discussed in detail later), the immediate annuity will play an increasing role for the financial professional as the financial professional attempts to help the consumer prepare for a more comfortable retirement.