The good news: Annuity products can be structured to strengthen your retirement
financial plan. In many cases, the best type of annuity for retirement is a
fixed lifetime annuity with an annual Cost of Living Adjustment that protects
your income from the affects of inflation. A fixed lifetime annuity gives you an
income stream for the rest of your life – no matter how long you live and it
offers a guaranteed payment – regardless of stock market performance.
The bad news: Annuity products can provide exactly what most retirees need –
guaranteed income. But, there are downsides to an annuity. For example, it locks
up your capital, so you lose flexibility. With an annuity you are trading
flexibility for guaranteed income.
The confusing: Not all annuities are created equal and many annuity products and
features are actually a bad bet for retirees – or anyone. In addition to
choosing between a fixed (the mostly good) or variable annuity, there is
also the matter of deciding where to purchase your annuity and which options to
include on your annuity contract. These options can be incredibly confusing.
There are different opinions and criticisms associated with
fixed annuities and their associated surrender charges. To dispel the confusion, it is important to
understand the need for the surrender charge.
First of all, surrender charges that are not disclosed by
the agent, are always bad. Obviously any aspect of a financial investment or
product, which is not disclosed, is always problematic because the client is
not able to properly rely on the product benefits or agent representations.
Surrender charges that are disclosed and explained by the agent are fine,
because this eliminates any concerns over liquidity or access to funds in later
years.
Surrender charges are a vital part of the annuity
product. They are in place so the
company issuing the annuity can guarantee the guarantees of the product. If you
think about it, any investment vehicle or product that offers benefits and a
potential return on investment has some type of fee or charge assessed for
early withdrawal. The company that
issues the annuity guarantees the safety of the principle, paying a minimum
interest rate and to pay an income stream at some time in the future if
elected. In addition, most fixed
annuities offer many peripheral benefits the client finds advantageous. An
example of a peripheral benefit is a premium bonus added to the accumulated
value of an annuity. Say the issuing
company offers a 7% bonus on an initial $100,000 deposit. Upon issuance, the accumulated value is
$107,000. The insurance company offers
the bonus knowing recovery of the $7000 will occur over time by holding the
investment. The insurance company cannot
afford to guarantee all these benefits if the client withdraws all the funds
within a period of time shorter than anticipated. The surrender charges are in place to
safeguard the annuity guarantees and benefits offered to the client.
It is important to understand, the more robust and
advantageous the benefits of the annuity are to the client, the more stringent
the surrender charges will be. A
passbook savings account from the bank doesn’t have surrender charges because
it offers no guarantees. Equally as
important to understand is the surrender charges are never assessed as long as
any withdrawals made from the annuity are not in excess of the liquidity
options offered. Annuities are typically
a long-term investment vehicle. If a
client knows access to their funds in short order is critical, they should
carefully examine and discuss the liquidity options and surrender charge
schedule with their agent to determine the best course of action.
Fixed annuities remain one of the safest, most reliable
investment vehicles today. There are many different annuities with different
rates, features, benefits and surrender charges, so it is important to shop
around to find the annuity that best fits your needs.
Despite the current economic conditions,
fixed annuities still remain a safe and popular financial vehicle. With total national sales exceeding $60 billion in the first half of 2009. This number represents an increase of almost 40% over sales the first half of 2008. This appeal to the conservative investor, which in general tends fall into the senior demographic, is simple; the advantages far outweigh the disadvantages, especially when the stock markets and the economy in general, are so uncertain.
The initial annuity advantage is derived from the nature of the product itself, which allows for a distribution of payments once the policy is annuitized. The amount and frequency of the payment distribution is determined by factors such as the value of the annuity, age of the investor and time period of the desired payments. Annuities can distribute payments over a "period certain" time frame such as 5 or 10 years or even for the lifetime of the investor, depending on their needs. Investors may need to utilize this income stream to supplement the loss of earnings from retirement, a spouse's social security or even increased expenses due to medical costs.
Unlike many other investment vehicles, the fixed annuity offers one very important advantage, which is protection of principle from market volatility. Products such as variable annuities, securities, and other investments can and do lose value when markets fluctuate. Over the last decade many investors have fallen victim to the stock market declines and lost the majority of their portfolio value. A 40 year-old employed investor has approximately 20 years and income which will aid in correcting market losses before retirement, whereas a retired 70 year-old has neither and therefore cannot afford risky investment vehicles. The fixed annuity performance is not directly tied to market performance and therefore the accumulated value never dips below the original principle.
A fixed annuity may not offer the robust potential of double-digit returns; it establishes guaranteed interest rates, which only add to the accumulated value of the investment, regardless of market losses. This provides the conservative investor a predictable and reliable rate of return. Substantial market losses may impact the renewal interest rate, however the fixed annuity has minimum guarantees, which prevent negative returns. Planning for retirement becomes less stressful and more peaceful when the investor has guaranteed rates built into the contract of the investment vehicle.
Although there are other advantages and options to explore concerning the fixed annuity, the three most important are income distribution, protection of principle and guaranteed rate of return.
At the time you purchase a contract you may be able to choose when benefit payments begin. You'll select between an immediate or deferred annuity.
Immediate Annuities
Immediate annuity contracts require a single premium payment. Benefit payments normally must begin within one year after the annuity is purchased.
Let's say you've decided you want benefit payments from your immediate annuity every month. You can usually get your first payment one month after you pay the premium.
If you want annual payments, your benefits generally will start one year after you pay the single premium.
You might buy an immediate annuity just before retiring if you want to guarantee a stream of payments over your lifetime.
This type of annuity is simply a way to convert a sum of money into a steady flow of income over a period of time.
Deferred Annuities
When you choose to start the payout phase at some future date, you have a deferred annuity.
You might buy a deferred annuity during your working years to provide retirement income. You could schedule benefits to begin on the date you anticipate retiring.
You can usually alter the date when benefit payments begin. The contract will specify what you must do to make such a change, but any change in the date will likely also change each benefit payment amount.
Deferred fixed annuities specify that you will earn interest on funds held by the company during the deferral period.
The contract will usually guarantee a minimum interest rate, but the actual credited interest rate will vary and be declared by the company from time to time. Declared rates can never be lower than the guaranteed minimum rate specified in the contract.
Accumulation phase - The period of time prior to annuitization.
Annuitant - A person who receives benefit payments from an annuity.
Annuitize - A method of receiving annuity benefits through a series of income payments for life or some other defined period of time.
Annuity - A contract with a life insurance company which guarantees an income for life or some other defined period in exchange for premiums you pay.
Back-end load - Company expenses that are charged at the time benefits begin.
Beneficiary - When provided in a contract, the person who receives benefit payments if the annuitant dies.
Contractholder - A person who pays premiums for an annuity. Often the same person as the annuitant.
Death benefit - A provision in certain annuity contracts that pays the beneficiary when the annuitant dies before the payout phase begins.
Deferred annuity - A contract that begins the payout phase at some future date.
Equity-indexed annuity - A contract that combines a guaranteed minimum interest rate with earnings linked to the performance of an external stock or bond index.
Fixed rate annuity - A contract that specifies your funds will earn a specified interest rate and guarantees a return on your premium.
Flexible premium annuity - A contract in which the amount of each premium payment you make can vary.
Front-end load - Company expenses that are charged at the beginning of a premium payment period.
Free look - A period specified in the contract (such as 10 days) during which you can decide whether to keep an annuity or return it for a full refund of your premium. Your free-look period is 20 days when you buy an annuity contract to replace one you already had.
Guaranteed interest rate - A minimum rate of interest specified in a fixed annuity. The actual rate the insurance company credits your contract at any given time may be higher but can never be lower.
Immediate annuity - A contract that begins the payout phase within one year after you pay the single premium.
Level premium annuity - A contract in which the amount of each premium payment you make stays the same.
Loan provision - A feature in certain annuity contracts that allows you to borrow up to a specified percentage of the value. Contract loans are usually subject to taxes.
Morality Tables - Statistics that project ones life expectancy based on many variables.
Payout phase (also called the annuity phase) - The period of time when benefit payments are being made to the annuitant.
Premium - The money you pay to fund an annuity contract.
Refund Annuity - Refunds part or all of the premiums paid if the insured dies before the start of the liquidation period.
Surrender charge - A fee the insurance company will charge you if you cash in (surrender) an annuity before the payout phase begins, or if you make a withdrawal larger than specified in the contract.
Variable annuity - Traditionally, a contract with no minimum guarantee (some newer products do include guarantees). Because the benefit amount depends on the insurance company's investment gains or losses, you share some part of the investment risk with the insurer.
Withdrawal privilege - A provision in many annuity contracts that allows you to withdraw an amount less than the surrender value, without paying a surrender charge. Any withdrawal may be subject to taxes and penalties.
There are two basic types of annuity contracts-fixed annuity and variable annuity. At the time you buy an annuity contract you will select between a fixed or variable. This determines how earnings are credited in your contract.
A fixed annuity provides fixed-dollar income payments backed by the guarantees in the contract. During the accumulation period of a fixed deferred annuity, your money (less any applicable charges) earns interest rates set by the insurance company spelled out in the annuity contract. Every fixed annuity has a current interest rate and a minimum guaranteed interest rate. The company guarantees that it will pay no less than a minimum rate of interest. During the payout period, the amount of each income payment to you is generally set when the payments start and will not change.
An equity-indexed annuity is a type of fixed annuity, but its returns are based upon the performance of an equity market index, such as the Standard & Poor's 500 Composite Stock Price Index (the S&P 500), the Dow Jones Industrial Average (DJIA), or the National Association of Securities Dealers Automated Quotations (NASDAQ).
The annuity's principal investment is protected from losses in the equity market, while gains add to the annuity's returns. These types of annuity contracts are complex and the amount of interest that is credited and when it gets credited to your annuity will vary depending on the particular contract.
Read your annuity contract carefully when you receive it. Ask your insurance agent or insurance company to explain anything you do not understand. If you cannot get answers to your questions, contact us, insuranceandannuities.com
A variable annuity offers a range of investment or funding options. During the accumulation period of a variable annuity, the insurance company puts your premiums, less any applicable charges, into a separate account. You decide how the company will invest those premiums, depending on how much risk you want to take. You may put your premium into a stock, bond, or other account, with no guarantees, or into a fixed account, with a minimum guaranteed interest rate. During the payout period of a variable annuity, the amount of each income payment to you may be fixed (set at the beginning) or variable (changing with the value of the investments in the separate account).
Remember that you, the owner, or annuitant, bear the investment risk as the value of the variable annuity increases or decreases based upon investment performance of the security. For this reason you should be certain that the annuity purchased is suitable for your needs and investment tolerance.
Annuity sales to senior citizens have significantly increased in recent years. However, as annuity sales have risen, so has a sense of confusion among consumers. This is due, in part, to questionable or deceptive sales practices employed by companies and agents looking to take advantage of uninformed consumers. It is extremely important, when considering whether or not to buy an annuity, to take the necessary precautions in order to make an informed decision that is best for you.
What is an Annuity? An annuity is a contract in which an insurance company makes a series of income payments at regular intervals in return for a premium or premiums you have paid. Annuities are most often bought for future retirement income, and can pay an income that can be guaranteed to last as long as you live.What are the Different Kinds of Annuities? There are several types of annuities, all of which carry varying levels of risk and guarantees. To get the most out of an annuity, it is imperative that you know the different options available to you, as well as the benefits each type provides.
Single Premium Annuity: An annuity in which you pay the insurance company only one premium payment.
Multiple Premium Annuity: An annuity in which you pay the insurance company multiple premium payments.
Immediate Annuity: An annuity in which you begin to receive income payments no later than one year after you pay the premium.
Deferred Annuity: An annuity in which you begin to receive income payments many years later.
Fixed Annuity: An annuity in which your money, less any applicable charges, earns interest at rates set by the insurance company or in a way specified in the annuity contract.
Variable Annuity: An annuity in which the insurance company invests your money, less any applicable charges, into a separate account based upon the risk you want to take. The money can be invested in stocks, bonds or other investments. If the fund does not do well, you may lose some or all of your investment.
Equity-Indexed Annuity: A variation of a fixed annuity in which the interest rate is based on an outside index, such as a stock market index. The annuity pays a base return, but it may be higher if the index increases.
Is an Annuity Right for You?To find out if an annuity is right for you, think about what your financial goals are for the future. Analyze the amount of money you are willing to invest in an annuity, as well as how much of a monetary risk you are willing to take. You shouldn’t buy an annuity to reach short-term financial goals. When determining whether an annuity would benefit you, ask yourself the following questions:
How much retirement income will I need in addition to what I will get from Social Security and my pension plan?
Will I need supplementary income for others in addition to myself?
How long do I plan on leaving money in the annuity?
When do I plan on needing income payments?
Will the annuity allow me to gain access to the money when I need it?
Do I want a fixed annuity with a guaranteed interest rate and little or no risk of losing the principal?
Do I want a variable annuity with the potential for higher earnings that aren’t guaranteed and the possibility that I may risk losing principal?
Understand the Product You are Buying: When it comes to annuities, inappropriate sales practices can occur in many ways and come from a variety of sources. Anyone can be a victim, but senior citizens remain a prime target. Here are a few ways to protect yourself: Always review the contract before you decide to buy an annuity. Terms and conditions of each
annuity contract will vary. You should understand the long-term nature of your purchase. Be sure you plan to keep an annuity long enough so the charges don’t take too much of the money you invest. Compare information for similar contracts from several companies. Comparing products may help you make a better decision. Ask your agent and/or the company for an explanation of anything you don’t understand. Remember that the quality of service you can expect from the company and the agent should be an important factor in your decision.
Verify that the company and agent are licensed. In order to sell life insurance in your state, companies and agents must be licensed. To confirm the credibility of a company or agent, contact your state insurance department. Check the company’s credit rating. Legitimate insurers have their “creditworthiness” rated by independent agencies rating is a sign of a company’s strong financial stability. You can check a company’s rating online or at your local library.
The proof is in the paperwork. As you complete your research and decide to purchase a particular policy, it’s important to keep detailed records. Get all rate quotes and key information in writing. Once you’ve made a purchase, keep a copy of all paperwork you complete and sign, as well as any correspondence, special offers and payment receipts.
Avoid Being Fooled by Deceptive Sales Practices Watch for the following red flags, which serve as warnings of possible deceptive sales practices:
High-pressure sales pitch. If a particular group or agent has contacted you repeatedly, offering a “limited-time” deal that makes you uncomfortable or aggravated, trust your instincts and steer clear.
Quick-change tactics. Skilled scam artists will try to prey on your “time fears.” They may try to convince you to change coverage quickly without giving you the opportunity to do adequate research.
Unwilling or unable to prove credibility. A licensed agent will be more than willing to show adequate credentials.
Remember, if it seems too good to be true, it probably is!
How
do annuities work?
An annuity is an insurance product: You make a lump sum payment or series of
payments, and the money grows tax-deferred at a fixed annuity or variable rate annuity (the
accumulation phase). In return, the insurer agrees to make periodic payments to
you for the rest of your life (the payout or annuitization phase). Annuities
also have a death benefit (this is where the insurance comes in) that entitles
your beneficiary to the value of your annuity or a guaranteed minimum,
whichever is greater.
But there are lots of twists. You can't withdraw the money until you're 59½,
or you'll be hit with a 10% penalty on earnings. Plus, you'll pay a surrender
fee if you tap the annuity before a certain period laid out in the contract
(usually seven years).
Another drawback: Earnings are taxed as income rather than at the long-term
capital gains rate. And annuities usually charge more than 1% a year for the
death benefit, but it pays off only if you die when your account has fallen
below the minimum guarantee.
What
type of annuities are there?
There's a whole slew of annuity products, but deferred annuities fall into
three main categories:
Fixed annuity. You lock in a guaranteed rate of return for periods
ranging from one year to ten years. Rates can fluctuate but will never drop
below your guaranteed rate. You won't lose money, but you won't have the
potential for growth you'd get by investing in stocks or stock funds.
If you meet the annuity-buyer profile, a fixed-rate annuity is worth
considering now -- especially if you have low risk tolerance and a shorter time
horizon for when you need the money.
Variable annuity. The money is invested in accounts similar to mutual
funds. Just like investing in a regular mutual fund, you can see substantial
gains or watch the value of your account plummet. But you'll pay higher fees
for the annuity (more on fees below). If a variable annuity is cheap enough, it
can make sense in certain
cases.
Plus, your heirs will owe tax on the earnings built up during your lifetime
(just as you would). Outside an annuity, the part of the inheritance
attributable to unrealized capital gains would be tax-free.
Equity-indexed annuity. Like a fixed annuity, you get a guaranteed
rate and fixed payments with this product. But it provides more opportunity for
growth because it's tied to an index such as the Standard & Poor's 500.
What
are the fees?
With fixed and equity-indexed annuities, fees and commissions are factored
in and lower your yield.
Variable annuities have a mortality and expense charge to cover the risk the
insurance company takes on to pay you lifetime income. Then administrative and
annual records maintenance fees are deducted. Typical annual fees run 2% --
nearly double those of the average mutual fund. There's also a yearly contract
charge of $25 or so.
And don't forget the surrender fee that applies if you withdraw money early.
Fixed and equity-indexed annuities are subject to these fees as well. These
penalties average 5.5% and generally phase out after you've been in the annuity
for a few years.
Who
should invest in one?
You shouldn't even consider investing in an annuity unless you are already
contributing the maximum to other retirement plans, such as an IRA or 401(k).
That's because those plans provide the same tax deferral as annuities but
without as many fees. If you invest in an annuity inside a tax-advantaged
account, you get no extra tax benefit.
The early-withdrawal penalty and surrender fees make an annuity useless for
short-term saving. With a variable annuity, for example, you pay higher tax
rates and higher expenses for the funds in the annuity than you'd pay for funds
outside the annuity. You'd need to hold an annuity at least 15 years for the
benefits of tax deferral to outweigh the extra costs (the breakeven point
depends on your tax bracket and the fees).
So the ideal annuity buyer is someone making the maximum contributions to
other retirement plans, who can live without the money until after age 59½, and
who is in at least the 25% tax bracket to take advantage of the tax deferral.
You also might be a good candidate if you're concerned about outliving your
savings because annuities can provide a guaranteed stream of income in
retirement.
Take a look at four basic cons you need to know about annuity.
- 1. With different types of annuities, you can never be sure about the terms and conditions for each.
Not all these annuities are the same in features. While it is simple
enough to understand fixed annuities as merely having fixed income for
a fixed period at a preset time, it is not for everybody to have an
easy grasp of how a variable annuity differs, or how advantageous
immediate annuity is over and above a deferred annuity in terms of
benefits, or conversely in terms of tax implications. There are some
with unfortunate experiences about annuities who say that some annuity
products are nothing but expensive, overly-made-up financial products
that do not deliver the expectations.
- 2. There is a possibility that you’ll get lesser returns for your investment.
Even though annuities are touted as best-yields, you can never be a
hundred and one percent sure about the returns if you are not careful.
While fixed investments like annuities guarantee a certain level of
return, this may not be that attractive to those who would rather take
a risk and be speculative, take a look at other high-yield investments
albeit riskier ones, and get better returns. The risk is somewhat
commensurate to the returns so financial advisers tell you that if you
are not willing to take the risk, you should not look for higher
returns. However, there are still investment options with fairly
moderate risks attendant to them, but will nonetheless ensure better
returns for your money. It all boils down to your making careful and
detailed study of the possibilities.
- 3. Annuities may not be all that flexible.
Fixed annuities especially will not allow you the flexibility to
vary or increase your income-earning potential. If there is an
emergency, you may not have ready access to your money, especially if
it has not been pre-stipulated. After lumping all your available money
now to an annuity, you should not look at future investment
opportunities anymore, as the fixed terms of an annuity may not allow
you to do so.
So consider this, you just had a windfall on your retirement
benefits or inheritance, and you instinctively placed the lot on
annuities. The flexibility angle comes to play here, because after
lumping them all in the annuity, you will no longer have access to that
lump until such time in the future as stipulated in the annuity terms.
And then again, you don’t have the flexibility in terms of emergencies,
because annuities are only able to provide the regular income over
time, and will not cover emergency or unplanned costs.
- 4. The fees and charges attendant to annuities may be prohibitive for some.
Before you finally decide on that annuity option, take a look at the
finer prints of the policy. Watch out for hidden fees. For all you
know, some of the negative feedback of insurance and investment clients
about annuities are focused on the high and varied fees attendant to
different kinds of annuities whether fixed or variable or deferred.
Here are 5 tips on fixed annuity that you may find useful in evaluating if indeed you made the right decision.
- 1. Check and validate how your fixed annuity works.
Try and look at your fixed annuity as the antithesis of life insurance,
the latter’s exact opposite. This is so because your fixed annuity pays
out money to you while you are still alive unlike a life insurance that
only your beneficiaries will get to enjoy after you die.
The money you shelled out today should earn interest or returns that
will accumulate over time and depending on your preferences will either
be taxed today or later when you begin getting paid out of the annuity.
The bigger you put in now, the more comfortable you are supposed to be
when you retire. You opt for a fixed amount that you would want to
receive monthly or quarterly when you finally retire. You also set the
time when you should start receiving that income.
- 2. Make sure that fixed annuity is what you need.
Talk to your insurance provider or financial planner. Determine what
you need for the future and try to see if your fixed annuity will be
able to deliver your expectations. While annuities
may be attractive investment options, what with the tax deferment
shelters and all, annuities are not usually the first investment or
retirement options. If you have savings and other retirement plans, try
and see if these will give you the flexibility and comfort level you
are looking for when you finally retire. If not, then you can opt for
fixed annuities. Try and see also if you have to invest on a fixed
annuity alone or would want to combine it with mutual funds.
The paramount consideration is that whatever mix you decide on,
whether it is fixed or variable annuity alone or in combination with
other funds or savings vehicles, it will satisfy your retirement
objectives.
- 3. Compare your fixed annuity plan with other types of annuities.
Go back to the basics and check your fixed annuity plan against
other types or forms of annuities. Compare your fixed annuity plan with
various products that can be immediate or deferred, fixed or variable.
Are you better off paying in lump sum today or over a period of time
through regular investments? Will you go for the lesser risk fixed
annuity that guarantees your fixed income in the future, or can you
handle a little risk here and there and go for variable annuity.
- 4. Understand how you get paid later.
Know the payout options available to you, which are practically
uniform across the different types of annuities. You may opt for life
only options, certain and life payments, fixed-period and fixed-amount
payout, or the joint and last survivor option.
- 5. Check the annuity issuing company.
Is your issuing company good on its word? Your annuity is only worth
it if the underwriting company is still around to make the payments to
you when you need them. Choose from among the best and most stable of
the issuing companies based on resource capabilities, track record, and
claims satisfaction.