I don’t know about you, but everywhere I turn someone is trying to sell me an annuity. The sales pitch tells me it’s a secure and risk-free investment, I don’t know about you, but that always makes me a bit wary. And when that happens, I figure it’s time to do some research of my own.
First of all, what is an annuity?
It’s an insurance company product. Yup, an annuity is basically a contract between an investor and an insurance company.
Annuities offer some retirement planning options that are worth considering:
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You can save money and defer taxes until you withdraw your money like you can with a 401k. But, the advantage is that the government doesn’t limit the amount of money you can invest.
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An annuity can provide repayment in a lump sum, lifelong income or pay you over a set period of time that you select. And, payments to you can be monthly, quarterly, semiannually or annually.
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There are annuities that include a death benefit for your heirs, similar to life insurance. Your beneficiaries could be entitled to the amount you invested plus interest less any withdrawals you’ve made, or the market value of the fund.
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You determine how much you want to invest and the risk exposure you want by selecting a type of annuity and the underlying investment options. Most variable annuities allow you to move freely between underling investment options such as fixed accounts, money markets, equities, domestic, international, specialty and sector funds which give investors options for growth, value and the ability to blend strategies. Some annuities even allow investors to choose between fund managers such as T. Rowe Price, Fidelity, Putnam, etc.
What about the insurance company?
Because annuities are backed by life insurance companies, it’s important to know the financial strength of the company that is behind the product. You can look up Life & Annuity ratings on WeissRatings.com. And from there, you can sign up with WeissWatchDog.com to be alerted to changes in the company’s financial strength. A “B” rating from Weiss is considered “good”, while an “A” rating is reserved for companies that are considered in “excellent” financial health.
Insurance companies offer a variety of annuities and they can get as complex as the day is long, but here are the basic annuity products that are offered.
Immediate Annuity
For an immediate annuity, you would give the insurance company a lump sum of money in exchange for receiving income on a regular basis, for a set period of time or for the rest of your life. This type of plan is usually purchased by someone close to retirement. When you select to receive income payments for life, the objective is that you will not outlive your savings. With an immediate annuity, you would begin to receive your income immediately, usually about a month after you sign on the dotted line. The amount of money you will receive is based on the amount of your deposit, the length of time the annuity is purchased for, and the guarantees offered by the insurance company. The return on your investment can be fixed or variable depending on the product you select.
Deferred Annuity
This type of annuity offers investors a way to save money tax-deferred until the money is withdrawn. The idea is to build the fund to provide an income stream or lump sum payment for a later date.
Whether you select an immediate or deferred annuity, you also must decide whether to invest in a fixed or variable annuity.
Fixed Annuity
Fixed annuities pay a “fixed” rate of return. They offer you a guaranteed rate of return, usually over one to ten years. If you select periodic payouts, they will be set and guaranteed. Your principal investment may be guaranteed as well. To accomplish this, the insurance company will invest the funds primarily in government securities and high-grade corporate bonds. There is generally a “surrender” fee to liquidate early which decreases the longer you keep the investment. You can invest a lump sum or make payments. The money grows tax deferred until you withdraw funds.
There are two basic types of fixed annuities: A Guaranteed Return Annuity and a Market Value Adjustment Annuity.
A Guaranteed Return Annuity features a guarantee that you will not receive less than the principal amount you invested if you surrender. This would be important in a rising rate environment because it would allow you to surrender and reinvest at a more lucrative rate. However, there is certainly a cost to this feature built into the fee structure, and the conservative investment structure needed to guarantee principal will limit the capture of upside market potential.
A Market Value Adjustment Annuity does not guarantee your principal if rates rise and you want to surrender your annuity. So your principal is exposed to the risk of rising interest rates. Since you’ve locked into an interest rate, like a bond, the value of your investment will be less than one that captures a higher market interest rate. These usually offer a higher initial interest rate because of that.
Fixed annuities are attractive for conservative investors looking for safety. People who are nearing retirement age who want a return on their money without exposure to market fluctuations and the recent volatility might select this product.
Variable Annuity
Your investment in a variable annuity will allow more flexibility in investment choices, but market performance will determine the value and the return you’ll receive. With a variable annuity, you can give the insurance company a lump sum or a little at a time. Your funds are invested based on the risk and return expectations you agree on with the issuing company. Underlying investment options range from conservative such as money markets, guaranteed fixed return accounts or government bonds to more aggressive choices such as growth equities and emerging market funds. Some variable annuity products have a ton of options and allow you to switch between them periodically without cost and without tax consequence.
Of course, when your underlying investment choices have market exposure, you will make money if the investments you chose grow, but you’ll lose money if the investments you choose go down in value. Ultimately that means that if you have decided to receive monthly payments from your annuity over a period of time, the amount of those payments will fluctuate based on the income stream your investments generate and based on changes in the underlying value of your investment.
Fees for variable annuity products are generally higher because of the additional investment options provided.
Variable annuities are attractive to investors that are comfortable with some level of market fluctuation. When markets are rising, there’s a chance to keep up with inflation especially over the longer term.
Hybrid Annuity
This type of annuity is a blend of the fixed and variable offerings. It allows you to blend a mix of conservative investments to guarantee a certain level of principal or income return, and then allows exposure to market fluctuations hopefully to allow the investor some ability to capture market upside. Of course, you also have the risk that some part of your principal and interest could be diminished by downward market moves.
What’s the surrender fee?
If you take money out of your annuity before it matures, there is usually a penalty called a surrender or withdrawal charge. The fee drops each year so it will be higher in the first few years and may reduce to zero later as you get closer to the maturity date. Immediate annuities usually can’t be liquidated so there is no surrender fee involved. The surrender fee allows the insurance company to recover its expenses and discourages contract holders from using their annuities like a bank account for liquidity. Some contracts will let you take out funds, sometimes up to 10% per year, without a charge.
How do I buy an annuity?
Annuities are offered through financial planners, college planners, banks and insurance agents. An insurance company actually issues the contract.
If you’re dealing with an insurance agent, make sure they are licensed by your state insurance department which is the primary regulator for insurance product sales. Often agents offer products backed by several different insurers, while others may work exclusively for one insurance company. Be careful to work with someone that will help select the best product for you, not the product that pays them the most commission.
In more recent few years, laws have changed so that banks and stock brokers now sell these life insurance products. Regardless of where you buy, the person selling you an annuity should be a licensed life insurance agent. And if you’re inquiring about a variable annuity, make sure the agent is also a licensed securities dealer in your state.
Again, no matter who you buy from, the financial strength of the insurance company behind the annuity is very important. Don’t buy without checking WeissRatings.com for the most up-to-date financial strength rating for any life and annuity insurance carrier. Several other companies provide information on insurers’ financial strength: A. M. Best Company Inc., Moody’s Investors Service, and Standard & Poor’s Insurance Ratings Service. However, Weiss Ratings is one of a very few truly independent companies because they don’t accept compensation from the companies they rate.
Things you should consider before buying.
- Annuities are not revocable. Once you’ve signed the contract, you cannot renegotiate so make sure you understand the ins and outs of the annuity you choose to invest in.
- Pick an agent that is state licensed, and check out their state registration and history. You will want to avoid professionals with a record of disciplinary actions, negative arbitration decisions and any litigation judgments.
- Make sure your representative is giving you the time you need to understand the product, demonstrates a good understanding of product options and has sufficient product offerings to meet your investment objectives.
- Compare the insurance companies that are issuing the products by checking financial strength ratings at WeissRatings.com. This is most important for a fixed annuity because the guarantees are going to be subject to the company’s ability to pay.
- Make sure the insurance company you choose is licensed to issue annuities in your state.
- Keep informed if the rating of the insurance company changes by signing up for “Alerts” at WeissWatchDog.com
- Get familiar with the fees to brokers and fees the insurance company my charge for managing the investment.
- Compare the investment choices that you can select from within the annuity and the frequency they allow you to move between funds.
- Compare surrender charges. Some funds have no surrender penalty for early withdrawal.
- Remember that if you withdraw money before you’re 59 ½ years of age, you may be subject to taxes and to the 10% federal income tax penalty.
As with any purchase, you want a quality product and quality customer service. Make sure you’re comfortable that your questions have been answered promptly and with information you understand so you can make decisions that will best meet your needs and investment objectives.
And be cautious.
As with any financial product purchase, you must do your homework. Often, promotions do not specify surrender charges or the costs of offering variable annuity death benefits, and greedy representatives can be misleading about the returns you can expect.
The main challenge you will face as an investor is to understand the various plans available and decide which features are the most suitable for you.
{ 13 comments }
I guess I don’t understand why anyone would want to give an insurance company all their money and have them hand you back a few dollars each month or whenever. If interest rates were to rise, wouldn’t it be the same thing to put your money in the bank and take out a certain amount of it each month? I’m sure the insurance companies don’t do this for nothing so there would be some fees withdrawn also.
An immediate annuity works like having a pension. If you are in your sixties already, you can get a stream of income for the rest of your life and your spouse’s life at a rate that would beat 5% interest rate on your money. Seniors are getting disgusted with our government and the low interest rates and are starting to lose confidence that they will raise the interest rate. When they do raise the interest rate, it will be because they have to and things are really in a mess. It’s almost a no-win situation with our government. Seniors with a limited amount of money are really getting “hit” in this economy. And if you leave it up to the republicans, the seniors will all end up homeless, sleeping in shelters.
Diane, maybe you should push for a government issued can opener to all seniors, so they will be able to open their can of dog food when they are hungry while they are sleeping in their shelter. You must know that is what the evil republicans want — for our seniors to eat dog food, right. You are probably nodding your demented head in agreement, which is why you are so full of it.
This isnt a republican or democrat issue its all of our politicians spending like crazy drunks. No one party is to blame they all are. The amount of government waste and spending on high paid public employees and entitlements and wars and every corp’s lobby with pork to there pocketbooks as well has caused this problem. Not mention the money we dish out to IMF FED and foreign countries that never back us anyways. The thing is seniors or anyone with a shred of knowledge of history understand governments are corrupt and always abuse money printing powers. Buy hard assets and you wont eat dog food… Even my Grandmother rest her soul never had any education beyond high school knew that owning a farm and rental property and gold and silver was the ultimate hedge against Politicians and bums on Wall street and those that run the FED or as I call it the “Private” reserve. These poeple eating dog food should have bought oil stocks and silver and gold and put part of there money into paid for real estate. Maintain control over your Wealth dont let others manage it or it will be gone. By the way a properly done real estate investment can be no management to the owner if he or she puts professional management in place. To leave money sit in a bank account is non sense unless its an emergency reserve which only needs to be 6 months worth of income. The rest of you wealth in dividend or royalty producing assets that will go up in value just like the cost of bread goes up or the cost of oil goes up. So to the starving seniors dont worry if you saved all your life your oil stocks and real estate and gold and silver wont be worth dog food when inflation doubles or triples ….Your portfolio will double triple right along with the market. Dianne the problem is this many Seniors didnt take responsibility for there own retirements by saving and investing. Instead they chose to go on cruises and eat out every week end and drive new cars and pay 30 years on mortgages living in newly constructed homes. Well no kidding there going to be broke LOL. Pay yourself first by investing 20% of your monthly income… then pay everyone else is the proper way to save for retirement. Imagine paying cash for your home then using all the money you would have paid as interest to a bank to invest in quality investments. That alone would make most financially stable during retirement years. Enough on my rant. Thanks Grandma for the advice to pay cash for everything and save 20% of what I make to buy investments and dont trust the GOV/FED! Her German lineage was where she got this information… Does the Word Wiemar Republic mean anything?
I have read where the commisssions on annuities can be up to 30%. I know that to attract sales persons to market the products would have to be expensive along with those support staff to aid the sales proceedures; but that leaves 70% of the funds to earn for the annuity. I also understand that the funds are not used in the investments a person chooses. Are these understandings correct?
I am still against all sorts of annuities. For me, it is so easy to deposit a big chunk of money into a discount brokerage account and invest in stocks/funds that pay at least 10% dividends. I am doing that now and I have been retired for 1 year already. Also, if we have some emergency, I can always sell any security and then use the proceeds for the emergency. You cannot touch your annuity principle at all. That is why I hate annuities. This way of collecting money each month, like in an annuity, can be risky, but the risk can be kept to a minimum by daily monitoring of news on each investment. If there is bad news on any stock, you need to sell it right away and then buy something else with a high dividend.
I wish I had NEVER purchased an annuity. Four years ago June 4, I invested $48K in an adjusted annuity as my brohter encouraged me to do so even though everyone else told me to stay away from them. I wished I had listened. When I met with the sales person, I kept asking him out of the $48K how much was his commission. His answer to me was that I did not pay him commission and that the insurance company (JNL) where the annuity would be purchased would pay him the commission. He was actually stretching the truth in that I would not personally be writing the check out to him for his commission, and that the insurance company would. He made it seem that the entire $48K would be invested in my name. Little did I know that he immediately received a fat commision of 8% or $3,840 which definitely reduced my invested dollars down to $44,160. In addition, he kept saying to me that the principal investment was always guaranteed and that I would never lose that and it would always be accesssible. Again, buyer beware! What he failed to tell me, was if I wanted to access my original investment, I was only able to ask for 1/20th of the principal. In other words, I could get it back but it would take me 20 years!….These people and companies should all be arrested. They are all “mini” Bernie Madoff clones……….So now the annuity has matured…..and it is now valued at $41K and they keep asking me to sign up for another four years, which I will not!. But I am $7K in the hole and what do I do.
Does anyone have information on Swiss Annuities??
Owen, some annuities have participation rates which determine how much of your principle investment participates in the growth. Find an annuity with 100% participation rate. Also, commissions are paid to the agents by the insurance company, not direcly from your investment dollars. Many fiixed annuities have no fees, where as variable annuities do because of the management fees that are inherent in open market products.
I have an annuity where if the market goes up I get a portion of the gain; if it goes down I do not suffer any loss. When I get a gain that becomes my new base. Also, each year I do not withdraw anything (10% allowed without penalty) then I get 8%. It is with Phoenix. Don’t know why these features weren’t described in the tutorial.
A Life annunity is a pension,you can buy it personally or your Co, will by it for you
Lifetime income,there always pro-con’s its worry free no fuss muss , tax depends in how its
purchased, it pays a agent up to 3% commission,small considering the training
its like anything else you get what you pay for,those how dream of huge returns ,wake upto a nightmare. Simple
So far no one on this blog has shown any knowledge on annuities thus far, so I will clear up a few misconceptions. Annuities do not pay commissions out of your funds, therefore if you invest $100,000 day one you will have $100,000 in your account value. As opposed to A share mutual funds where you will most likely pay a 5% load or more and your value day one would be $95,000. Annuities are appropriate for someone who wants income now or in the future as they are designed to provide income streams and tax deferral if the funds are non-qualified. It seems the #1 misconception of annuities is that you must give up all control of your money and this couldn’t be further from the truth. You only give up control if you annuitize and with the new income riders which have been developed over the past 5 years or so you can actually take a guaranteed lifetime income without annuitizing, which means your money stays invested and hopefully growing. There are 3 main types of annuities… Variable (underlying investments are mutual funds) or fixed/indexed (principal is protected) or Immediate (Pension like, you must give up control). Depending on your financial objectives an annuity may or may not be right for you. For example, if you would like to stay invested in the stock market at retirement or near retirement but you cannot afford the possibility of a 30% loss since you need this money for income during retirement…many variable annuities will guarantee your income or death benefit even if your account losses 50% or more. In fact, many annuities will guarantee 6-8% for income purposes regardless of market conditions, of course there is a fee for this benefit. Fixed annuites guarantee your principal and indexed annuities do as well but your interest rate can be linked to an external stock market index. Most annuities have surrender charges and money you may need for an emergency should not be part of an annuity purchase. I recommend consulting an independent financial advisor, not a stock broker because most have no clue about how annuities work therefore do not recommend them because they would rather sell you A share mutual funds and charge you a 1% wrap fee per year, with no guarantees whatsoever. All annuities will allow you to take out 10-20% withdrawals per year without penalties. They are made for income and they provide guarantees, unlike any other investment including you preferred stocks. The gentleman who mentioned preferred stocks above is providing 1 years worth of results and good for him that his results were positive but unfortunately it doesn’t consistently work this well over time. Preferred stocks can go up and down in value. There is also no such thing as a 30% commission on an annuity, that is simply absurd but more realistically you can figure 3-7% and again they are built in to the product just like a life insurance, auto insurance, health insurance policy. All financial products have some type of fee or commission paid, it is a for profit industry. A fee only adviser will typically charge 1% in addition to portfolio expenses therefore, over 10 years you will pay 1% on hopefully an increasing portfolio which makes the fee increase as well (10-12% over 10 years with zero guarantees) vs annuity (3-7% on initial investment) and provides guarantees depending on your choice of annuity. Which would you rather base your retirement on…the opinion a fee based adviser/broker or a contractual guarantee?
Jay,
You fee structure there is way off. The 1% charge for fee-based assets does not rise, the 1% stays the same and the account value hopefull grows. It’s an incentive to grow the account. As the money grows the broker receives more of a fee based on the higher account value, not the percentage going up!
Variable annuities pay the agent 3-7% up front, which the client does not pay. The client pays the the 3.5% – 5% (conservatively) every year for the life of the contract! Hefty fees if you ask me. That fee is assessed on the benefit base and not the account value. So if the accoutn value drops the client is still charged on the HIGHER benefit base.