Finally, The Absolute Straight Scoop On What You've Heard About Annuities.
The Definition of An Annuity
What is an annuity? The simple answer is a contractual agreement with a financial institution, almost always an insurance company, to provide guaranteed minimum returns on your investment. Then, when you are ready to take distribution of the money you’ve accumulated, it will be paid to you in an income stream you can’t outlive. Annuities are a simple concept and one that has been around since the Roman Empire. Think of annuities as a safe place to grow your money and protect you against outliving your money.
The Bad Press
It doesn’t take long to learn from the internet that annuities are bad. Maybe your friend at the salon or golf course counseled you away from them too. Let’s take a look at some common misconceptions of modern annuities and address them head on. First a little background.
It Is A Fixed Annuity
We need to distinguish which kind of annuities we are talking about. This article will deal with the safest type of annuity, the fixed annuity. It is NOT tied to the stock market and it includes a contractual minimum guarantee paid to you by an insurance company. There are two main types of fixed annuities. The first is the multi-year guaranteed annuity. This annuity pays you an interest rate declared by the company for a specific period of time, anywhere from 1-10 years typically. Then when the period expires the company will offer or declare a rate for you to renew. The other type of popular fixed annuity is the Fixed-Indexed annuity. It has a minimum guarantee declared by the company, but it will also credit your account based on a percentage of a market index, typically the S&P 500. Your money is never IN the market, but is credited based on market rises. When the market goes down, you lose NO money and no locked in gains from the previous year. No one has ever lost money in a fixed annuity based on the fluctuation of the market.
The Back Story
In the 80’s, annuities were a simply structured product used for lottery winners, and people paid in lawsuits. If you are a teacher, you know annuities are a part of your retirement structure. Annuities have and continue to keep educators retiring comfortably and worry free for generations. Annuities were then and continue to be used by teachers, professors, clergy and other non-profits around the country as well as the source for guaranteed payouts in lotteries and lawsuits.
There were few features and little competition until the nineties. After the stock-market crash of 1987 and increased competition amongst companies, a string of product innovation and consumer focused annuity products emerged, and continues to this day.
Common Complaints About Annuities Answered
“You’re money is locked up, if you put it into an annuity you can’t touch it until you retire.”
Answer: Annuities are designed for retirement and certainly money that you need for living expenses before you retire shouldn’t go into an annuity. You can access funds from your annuity, even during a period where you have surrender charges. These surrender charges are there for two purposes. They are used as a deterrent that keeps you from dipping into your retirement money before it is time, and secondly, it gives the insurance company a set amount of time to invest that money in long term portfolios.
After the first year, in most Fixed Indexed annuities you can withdraw 10% and each year thereafter without penalty. In as short of an 13 month period you can withdraw 20% of your money penalty free. There are also riders available that will allow you access to your money in case of nursing home confinement, as well as terminal illness.
“They keep your money, when you die it’s all gone.”
Yes, but no. When your annuity matures, you can take the money out in a lump sum with no obligation to start an income stream. You can “annuitize” which means to turn it into an income. You don’t have to use the entire amount, and you can use it to provide income for both you and your spouse for as long as you both live. You can structure your payouts to last for a certain period of time 5, 10, 20 years then they stop, or you can have the income that lasts your lifetime, no matter how much you paid into your annuity, the payments will never stop even if they exceed the amount of money you put in.
“The commissions and fees they charge are outrageous.”
This is where a lot of confusion comes into play based on the type of annuity you are talking about. Variable annuities which are tied to the stock market are rife with fees, commissions and loads. If you have ever taken the time to read the prospectus of a variable annuity, underline how many times the word fees are referenced in the document. They NEVER go away and eat at your lifetime earnings. Fixed annuities credit your account dollar for dollar. If you put 100,000 dollars into your account, 100,000 dollars is credited to your account with no recurring fees, commission, loads or charges added to your account. There can be certain riders that are added to a fixed annuity that you choose upfront that may add an additional charge but are customized to your choice and situation. Commission are typically paid to the agents who sell and service fixed annuities, but are paid directly by the insurance companies and not taken from your account. Whereas variable annuities fees and commission are usually taken from your account annually.
“The returns on annuities are bad, you should invest in a balanced portfolio, you will make more money in the long term.”
The stock market and equities deserve a place in many people’s portfolio. When you grow closer to retirement you can’t afford a massive fall in your account values and hope they return. If you’re in your 20’s there is a greater chance of recovery. With a fixed annuity you NEVER lose money due to stock market declines. For those that felt the sting of the last recession, they ended up working longer, or retired at a significantly lower quality of life.
Most of the “advice” you are hearing is based on old information, or the wrong product. Today’s fixed annuities offer a wide array of options and choice. They are a smart and flexible way to set aside money for retirement and income. Annuities are not for everyone and not for all of your money. Annuities offer a way to take control of your income planning as a pre-retiree and retiree. Safe, secure compound growth, with tax advantages, and the ability to produce an income you can’t outlive are some of the stellar features of annuity. Do your research, get the facts, and talk to professional retirement and income planner.