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:
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.
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.
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.
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.
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.
http://www.moneyandmarkets.com/do-you-want-to-invest-in-an-annuity-44026
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