What you need to know about annuities before speaking to your financial advisor.
Annuities are complicated insurance contracts in which only you and your investment professional / insurance agent can determine if a specific annuity is right for you. However, here are the basics of annuities and how they work.
Annuities are insurance contracts in which you are essentially getting insurance protection against outliving your retirement benefits. There are many aspects to these contracts. A helpful general outline to look at all these aspects is the following:
A) Determine if you want an immediate annuity or deferred. If immediate jump to section C. If deferred go to section B.
B) Review your different deferred options. Once the term is done you can typically leave it invested where it is, withdraw for cash or select the payout phase if you have reached the appropriate age. If you are ready for the payout phase review section C. (You should be aware of the payout options available even when considering a deferred and should include this in your discussion with your advisor.)
C) Payout Options
A) If you are ready for the payout phase within the next 12 months you may choose an immediate annuity. With this you place single large amount up front and begin getting payments. (Payments usually start within a year that they issue you the contract.) A common scenario is where someone uses investment funds or a life insurance payout to fund the annuity payout.
If you are going to retire in upcoming years but want to start planning you can ask your advisor about a deferred annuity. Most insurance companies will have the option of funding with a single lump sum premium or via flexible payments where you are able to fund the annuity as you want along the way. Either way, from when you make each investment there are usually surrender charges if you cancel during a certain period. Usually, the longer you hold the contract, the lower the surrender charges until there are no more surrender charges.
B) In preparing for your retirement, speak to your advisor to go over all your retirement options. If you qualify for a deferred annuity there are many ways to fund it. If you have a lump sum to invest (i.e. you obtained an inheritance) you may discuss a Single Premium Deferred Annuity. For many the Flexible Deferred Annuity which allows frequent contributions is the most favoured. Regardless of whether you wish to make a one time lump-sum payment or many payments over time there are various types of deferred annuities to choose from, here are the three most common:
• A Fixed Annuity will guarantee at least a fixed rate during accumulation period. Many will offer a fixed amount during the first year and then at least x rate during the following x years until there is no surrender charge and most will guarantee your principal (your payment amount into the annuity). One positive attribute of the fixed annuity is that the insurance company is taking risk and guaranteeing at least a specific rate of return and one potential negative is that this rate may not keep up with inflation causing your purchasing power to erode over time.
• Equity Indexed annuities are a kind of hybrid product where renewal interest rates are linked to a market related index, such as the MSCI All Country World Index. The positive is that there is typically a guarantee on the principal provided it is held for a certain time period and some guaranteed minimum returns as well as some percentage of the gains in the market. You may wish to compare the fees between this and a fixed annuity with your advisor to see if this is for you. This link to a market related index feature helps to provide some protection against loss of purchasing power due to inflation. Typically the contract is held for some minimum period of time. Surrendering the contract beforehand can lead to a return of principal slightly less than what was invested in many cases due to the surrender charges.
• Variable annuities are probably the most complicated of the deferred annuities. The value of the contract will fluctuate according to the investment you make in “separate accounts”. When investing you purchase “units” in the separate account and when you have payments made to you during the pay out phase you are redeeming the units for the payout. The positive of the variable is that you can make the investment in various separate accounts and enjoy the reward of their performance in the market. The potential negative is that there is no set guarantee on the performance and you bear the risk of the investments and not only will you pay fees for the annuity but there are management fees for the separate accounts in which you are purchasing units. There are also many “riders” which you can purchase for an additional annual fee. One such rider may “lock-in” year end market values for the purpose of the death benefit payout. Many companies offer a variety of features/riders but each of these riders will cost, so discuss with a professional which ones are available and which would be of most value to you.
C) Annuity payment options may vary from one company to another but here are six basic options that are quite common. Aside from the amount that you have accumulated or lump sum you are putting into your annuity, your age will be an important factor in determining what the payments will be. In addition, the payments options below will vary in payment amounts due to the risk level that the insurance is taking and the benefit to you.
• One of the higher paying options is the “Life Income”, where you receive payments only for as long as you live then payments stop. The positive is that you have peace of mind in not having to worry about outliving your payment option and the negative is that if that time comes sooner than anticipated the insurance company will not make any further payments to any beneficiary.
• The “Life Income Period Certain” option tends to pay a bit less than the Life Income but has an added benefit. It guarantees payment for a fixed period and if you outlive the period it will continue to make payments. Should something happen sooner than anticipated your beneficiaries will still receive a payment until the period is complete.
• The “Life Income with Refund” is a payout option that will pay for the as long as you live and if the payout total has not matched the payment amount you made into the annuity the beneficiary you designate would normally be able to receive a payment for the difference in installments or in a lump-sum payment.
• The “Fixed Amount” payout option will pay you for as long as the value of your annuity (referred to as principal amount) and interest will allow. The negative with this option is that you can potentially outlive the payout amount and the positive is reflected in the payout amounts relative to some other options.
• The “Life Income Joint and Survivor” payout option is popular with many married and life partner couples. The payout option is to both parties while both are alive. When there is only one surviving person the payments continue at a reduced rate. (Make sure you know what that percentage rate is beforehand) One positive is the peace of mind for both you and your partner and the negative is the initial payment amount you need to achieve the desired monthly payout amount.
• The “Joint Life” is also popular with many married and life partner couples and will pay only while both parties are alive. The positive is the payment amount relative to the “Life Income Joint and Survivor” payout option but of course the surviving party will not receive any payments. You will want to discuss this option carefully with your advisor to ensure you have the appropriate estate planning for your surviving spouse or life partner.
Here are some questions you may want to ask your Financial / Insurance Advisor: How is the insurance company rated in terms of financial stability? Should I split the assets I want to put in an annuity into more than one insurance company so I do not have all my eggs in one basket? How does this fit into my overall retirement planning including qualified retirement accounts? If you are investing a qualified plan into an annuity, what are the specific benefits you are achieving by doing this since you will not receive any added tax-shelter benefit? If you are purchasing a deferred annuity, when can you withdraw all the cash without penalty? Are there special provisions that will allow you to take out funds without penalty? (I.e. nursing home provisions) If you are doing a 1035 exchange, what are the benefits for making this exchange, what are the surrender charges on the existing contract and what are the new surrender charges for the replacement contract? If there are bonus credits, how does this compare to a similar product without the bonus (including fees)?
Ultimately, asking all the questions that are important to you when you speak to your advisor will help him or her put together the right retirement strategy for you and will give you the peace of mind in your investment decisions.
