Due to all of the contract types, features, and other bells and whistles associated with them, it’s easy for fixed deferred annuities to confuse and confound those who are considering adding one to their financial portfolios.
Here, then, is a wealth of information that should help you gain a better understanding of these tax-deferred insurance products--traditionally designed for retirement saving--before you go ahead and buy one.
Annuities could be called the inverse of life insurance. The author of this Forbes article put it best when they said that, “unlike life insurance, which protects against an early death, annuities protect against the risk that a retiree will live so long he’ll outlive his savings.”
Annuities, in general, are contracts with insurance companies that can provide you with a regular source of income for a set period of time. This can include the remainder of your life.
Also, going back to the earlier comment about annuities often being confusing, they come in a number of types, including immediate or deferred, as well as fixed, variable, or equity-indexed.
You can get paid now, or later. Immediate and deferred annuities are pretty different beasts, there’s no doubt about that. That’s because immediate annuities begin paying out no later than one year after you pay your premium, while payments related to deferred annuities usually don’t start for many years after that.
Fixed, equity-indexed, and variable annuities differ quite a bit, too. One of the hallmarks of fixed annuities is that, much like bank CDs (certificates of deposit), they offer guaranteed rates of interest, and for periods ranging from one to 10 years. (After that, they can fluctuate, but they’ll never drop below the guaranteed rate.)
Equity-indexed annuities are similar in that they also provide buyers with a guaranteed rate and fixed payments. That said, they veer off in their own direction by being tied to a stock index (or something similar).
Variable annuities, on the other hand, are known for investing a person’s money into accounts that are similar to mutual funds. Because these accounts tend to fluctuate along with the economy, though, they’re riskier than fixed annuities. (Depending on how things are going at any particular time, you can make a lot of money or you can lose your shirt.)
- Assuming you go with a deferred annuity of some sort, you may like to know that most varieties often “work” in the same way. For example, most deferred annuities have what are known as “accumulation” periods and “payout” periods. During the accumulation period, the value of your annuity changes based on the type you decided to invest in, while during the payout period, the annuity makes payments to you.
Most annuities also have some sort of “death benefit” associated with them. But they usually have various charges associated with them, too.
Income tax on these annuities is deferred. The money that’s built up (as a result of interest) within a deferred annuity—or within most such annuities, at any rate—is tax deferred, which means you don’t have to pay income tax on those earnings until they’re taken out of the annuity.
Low investment minimums are another of the “advantages” related to deferred annuities. Along with their guaranteed rates of interest, these annuities also usually require just a small initial investment (sometimes as low as $1,000 or $2,000).
Fixed deferred annuities also let you choose how (and not just when) you’d like to be paid. Insurance companies offer a wide array of payment options when it comes to how these products. Want to receive your “guaranteed income” for the rest of your life? Go with a “Life Only” (or “Pure Annuity” or “Straight Life”) plan. Or maybe you want to receive payments for as long as you live, but you also want your beneficiary to receive them if you pass away during a certain period after you begin being paid? Select a “Life Annuity with Period Certain” plan. Another possibility: choose the “Joint and Survivor” option and your annuity will pay out as long as either you or your beneficiary is still alive.
The risks associated with fixed deferred annuities could be a disadvantage for some. As suggested earlier, although the rates associated with fixed deferred annuities are guaranteed for a certain period of time, they can drop once that period is over. They won’t go below the guaranteed minimum. But that minimum may be lower than what’s being paid for other, comparable investments. This could prove to be a problem if that prompts you to want to withdraw your money early and you have to pay hefty “surrender” charges as a result.
Unfortunately, some charges and fees tend to be associated with fixed deferred annuities, too. A few examples: contract fees, transaction fees, “surrender” or withdrawal charges (these come into play if you take part or all of the money out of your annuity during a set period of time), percentage of premium charges, and premium taxes.
As always, if you don’t understand any of the charges that are associated with your particular annuity, ask your agent, your financial advisor (if you have one), or even someone at the company that sold you your policy.
Have a conversation with yourself to figure out if a fixed deferred annuity is right for you. If you’re still unsure as to whether or not a fixed deferred annuity is right for you, ask yourself the following questions, provided by the National Association of Insurance Commissioners and the North Carolina Department of Insurance:
- How much retirement income will I need in addition to what I will get from Social Security, my pension, and any other sources?
- Will I need that additional income only for myself, or will it be for myself and others?
- What will I do if the income from the annuity isn’t as much as I expect it to be?
- When will I need to start receiving payments?
- Will the annuity I’m considering let me gain access to my money when I need it?
- Will I be able to keep my money in the annuity long enough to avoid paying surrender charges?
- Which of this annuity’s benefits and features, other than tax deferral, make it appropriate for me and my financial goals?
Here are a few questions you may want to ask your agent, broker, or whichever financial professional you’re working with, too. As with the above, the following questions should help you decide if a particular fixed deferred annuity is the right investment for you:
- What is the initial interest rate and for how long is it guaranteed?
- What is the guaranteed minimum interest rate?
- How much will this contract cost annually, including all expenses?
- Is this annuity adjusted for inflation?
- Is some sort of death benefit included with this contract?
- What is the surrender period?
- Will I be allowed to withdraw some amount of money from the annuity without paying surrender or other charges? If so, how much can I withdraw before those charges are imposed?
If you don’t understand something, feel free to bend your agent’s ear. Buying an annuity is a big deal. They usually involve a rather hefty investment on the part of the person purchasing one, and they’re likely to have a significant impact on that person’s financial future, too.
So, if something doesn’t make sense to you, or if something confuses you—such as the charges or penalties that may be associated with your particular annuity—ask your agent or broker or whoever sold you your contract to explain it to you.
And if that person isn’t able to answer your questions as well as you’d like, contact your state insurance department.
Look past the “teaser” rate and the pep talk. It’s possible the person you turn to while shopping for a fixed deferred annuity will try to entice you with an interest rate that’s higher than what’s currently offered on bank CDs.
Should that happen, keep in mind that the rate in question may only be guaranteed for a short period of time. After that, it could go up, but it also could go down.
Although most fixed deferred annuities are likely to promise a guaranteed minimum interest rate, that could be lower than what’s being offered elsewhere, so don’t put too much stock into the initial rate that’s tossed at you.
You’ll want to thoroughly review your annuity contract after it’s in hand. And not only that, but you’re going to want to review it within the first week or so after it’s sent to you. State law provides you with a set number of days to consider the contract you’ve just purchased.
If you decide during that time that it’s not right for you, you can return it to your agent or the company that sold it to you and get your money back.
Never forget that annuities are long-term contracts. If you’re looking for a short-term insurance or investment product, you’re going to want to look at something other than a fixed deferred annuity.
Such annuities are set up to provide for their owners over the long haul. This is especially evident in the way that fees and penalties are set up, as mentioned earlier.
So, be ready to make a lengthy commitment should you decide to hand over your hard-earned cash for one of these products.
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