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Planning to Purchase An Annuity? Consider This First


It seems as if annuities have been a hot topic again as advisers and investors continue to wonder when the next financial crisis will hit. It’s been a decade since the last major downturn causing many folks to start bracing for the next one. Whether looking to maximize the benefits of tax-deferred accumulation or create an immediate stream of protected retirement income, annuities are unique products that might be useful in your portfolio.

There are several different types of annuities, and they aren’t all appropriate for every situation. If your advisor suggests investing in an annuity, or you’ve been considering purchasing one, it is always recommended to do your homework beforehand. Here’s a look at five important questions you should ask before signing on the dotted line, according to the experts at MarketWatch.

How does an annuity help me in retirement?

The number 1 fear of most retirees is running out of money prematurely in retirement. Many tax-deferred qualified retirement accounts, like 401(k) or IRAs, give retirees the ability to accumulate assets to draw down in retirement. But an income stream from these sources is subject to market risk and is not infinite. On the contrary, an annuity is like an insurance policy, allowing you to convert your investment into a guaranteed stream of protected income for life.

There are so many options. How do I determine what is right for me?

While there are several options for you to pick and choose from, there are just a few major differences between annuity products that you should be aware of. For starters, you will need to decide when you will receive income. Immediate annuities will begin making payments soon after you make the investment while deferred products allow investors to grow assets tax-deferred before choosing when to begin collecting income. Your retirement date will obviously play a role in this decision.

You can also choose an annuity product based on growth potential. Variable annuities are tied to the market for greater growth potential, but come with more risk as the contract value fluctuates. Indexed annuities can provide some upside potential when markets are up, but also provide some protection from downturns. Fixed annuities provide a guaranteed interest rate regardless of what’s happening in the market. Many advisers have been pushing fixed index annuities (FIAs) as an alternative to bonds in recent years.

What are some fees I may be charged?

Many retirement accounts, such as a 401(k) or IRA, are accompanied by fees. It isn’t unheard of for fees on variable annuities to total 3% a year or more. The industry average of five typical fees include:

  1. Mortality and expense fees (M&E): 1.35%
  2. Administrative fees: 0.10% – 0.30%
  3. Investment management fees charged for the underlying funds inside the annuity: 1.00%
  4. Fees for optional riders or insurance guarantees: 1.00%
  5. Surrender fees which may be charged for withdrawing funds from an annuity too soon: as much as 8.00%

There may also be commissions associated with the sale of the annuity, typically ranging from 5% to 9% of the amount invested. Your adviser can explain all of the fees associated with an annuity, and help you evaluate them better. If fees are a concern, consider low cost and no-load annuities.

Is the income truly guaranteed?

Annuities are simply contracts with an insurance company, so at the end of the day, the guarantee of future payments is only as good as the financial strength of the insurer. There are many choices for guaranteed income available, including a range of different optional living benefit riders designed to protect portfolio assets or income payments during market downturns. Financial strength is regularly reviewed and rated by five independent firms, and each state has a Guaranty Association to protect policyholders in the event that the insurance company is unable to meet their financial obligations.

Are there other ways I can use my annuity?

There are many ways that an annuity can be used to meet a range of investing needs. For example, investment-only variable annuities are built specifically to maximize the power of tax-deferred accumulation, with lower costs and more fund choices. IOVAs can be especially beneficial for high earners and those with high net worth, who often max out qualified plans, like 401(k)s and IRAs, and are wanting another tax-advantaged investment vehicle. IOVAs allow virtually unlimited contributions, making them an option when trying to shelter a large cash infusion, like the proceeds from selling a business.

Annuities can also be used for tax-efficient legacy planning, offering an array of optional death benefits. These proceeds are often tax friendly and can be transferred to heirs without the hassle of probate and legal fees. Advisers can also help clients develop a tax-efficient strategy to fund trusts in a low-cost IOVA, allowing assets to accumulate and grow tax-free.

While annuities can be suitable for many investors, they are not appropriate for everyone. They are long-term investments and might not make sense for those who want immediate and unrestricted access to their money. Before investing in an annuity, it is crucial to discuss your retirement income needs with a trusted adviser, and determine if an annuity is a good fit for your financial plan.

Written by Rachel Summit

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