Annuities

Annuity products are not right for everyone. They are often pushed on to clients for the wrong reasons. However, for some people they can be helpful. There are benefits, but also drawbacks to annuities. Annuities are complicated products and should be carefully evaluated.

• An annuity is a contract between you and an insurance company.
• An annuity is an insurance product that guarantees a future stream of payments.
• An annuity helps protect you against outliving your assets.

Life insurance is available to protect you in case you die too early; an annuity is available to protect you in case you live longer than you expect.

Who should purchase an annuity?

• If you are seeking stable, guaranteed retirement income regardless of how poor the economy performs
• Wish to place your hard-earned money in an insurance product that may be contracted to grow over the years.
• Wish to exchange a large sum of money on hand for a series of cash flows for as long as they live
• Fear outliving your assets

Why should I purchase an annuity?

• Lower risk option with a guaranteed rate of interest, similar to certificates of deposit (CDs)
• Interest is earned on a tax-deferred basis, taxes are not paid on interest until individual withdraws from the annuity
• Guarantees lifetime income, a policy holder can never outlive the payments, even if benefits exceeds the initial premium
• The insurance company backs it’s annuities, but if the insurance company fails, the state guaranty association will act as secondary protection. However, each state has a maximum protection amount that you should look into.

Types of Annuities

Immediate Annuity

• Payments begin as soon as the policy is purchased
• Usually purchased with a large, single lump sum amount
• In exchange, regular payments are paid out to the beneficiary for a set period of time or for the rest of the beneficiary’s life

Fixed Deferred Annuity

• Money is paid in and earnings are tax deferred and grow at a specificed interest rate before the beneficiary starts to receive regular payments.
• Principal investment is guaranteed. No money is lost unless the insurance company becomes bankrupt, in which case, there is regulatory protection for annuity policy holders to
• May have a surrender period of anywhere from 2 to 10 years, where penalties are incurred if money is withdrawn before the end of the surrender period
• Fixed and guaranteed minimum interest rate

Indexed Annuity

• Insurance contract whose interest rate is dependent on the performance of a particular market it is indexed to (e.g. S&P 500)
• Also guarantees a minimum interest rate regardless if the index the policy is linked to performs under the minimum interest rate

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What are the drawbacks?

Commissions tend to be high, which means unscrupulous advisors or agents push them on clients, even when they are not appropriate.

Surrender Charges are expenses you are charged for pulling your money out of the annuity in the first few years after you purchase it. These charges usually get reduced the longer you own the annuity and usually go away.

High Annual Fees will depend on the type of annuity. You can be charged an annual insurance charge of 1.25%, an investment management fee of 0.5% to 2%, and various other fees of 0.5% or more. If you add all the charges up you could be paying fees of 2% to 3% or more annually. Mutual funds and index funds typically have fees that are much less, but are not guaranteed.

Tax Penalties exist with annuities. As with a 401K or an IRA, it may not be a good idea to take money out before the age of 59 ½ because withdrawals made early may be hit with a withdrawal penalty. You should consult your tax attorney or accountant to understand this risk better.

Complexities in annuity contracts often mean people do not understand what they are getting. It is very important to fully understand what you are getting.