Many retirees either have or are thinking about investing some of their hard earned money and savings into annuities. There are many moving parts and investors should be aware when annuities explained by their insurance agent, stock broker or financial advisor, there are very high commissions involved that can somewhat cloud the facts.
One of the most sought after retirement wishes of retirees is that their money will last for the rest of their life allowing them to live the kind of lifestyle they always dreamed of. In some cases, annuities can be an integral part of that solution, but it is the responsibility of the investor (you) to understand how these products function and how they fit into your overall financial plan.
Annuities can be suitable to product Ira income which grows tax deferred, and can add a layer of protection, but can also be appropriate for post tax income in a regular non-retirement account.
There are two primary types of annuities.
Fixed Rate Annuities that provide a tax deferred rate of return that is agreed upon between you and the insurance company at the time of purchase. The rate will be consistent with whatever the prevailing rates at the time are. These can be reasonably good investments if you’re not interested in market risk and would rather have a specified rate of return for a specified period of time. They are similar to a CD without the FDIC guarantee. In the case of a fixed rate annuity, your money is as safe as the insurance company you make the agreement or contract with.
Variable Rate Annuities are much more complex and have many options to chose from depending on the insurance company, their current offerings and how much you’re willing to pay in fees. You can purchase a variable annuity, invest the money in mutual funds within the annuity and have almost any form of traditional asset allocation that you can get outside the annuity. The primary benefit the annuity provides is a death benefit (not really a benefit to you 🙂 ) which usually is locked in at the amount of money you originally put in or invested, and in some cases, can increase by a set percentage each year for a fee. Many annuities today offer a “living benefit” also known as an “income rider” which provides a set rate of return that the annuity will produce each year, for a fee of course, but her is where it gets complex.
Here’s an example of how a “living benefit” might work:
You put $100,000 into a variable annuity in 2007 at the peak of the market at the advice of your financial advisor. She said that the money would be protected because if the market value goes down, your beneficiary will receive a death benefit of at least the initial deposit of $100,000 (provided you haven’t made any withdrawals). Also, there is a rider (addendum to the contract) that says each year the contract value will increase by 6% compounded annually, also known as a living benefit. You must be aware that for all these added benefits you are most likely paying between 2% and 3% per year in fees that are deducted from the value of your funds on a regular basis. The insurance company charges fees for the benefits and the mutual funds have normal expenses built into the funds as they all do.
There are some pitfalls to these annuity contracts, but if the market has underperformed your expectations or the historical averages, you may find them beneficial in terms of the added benefits, but in the good years, you can find yourself paying fees that have no benefit. Like most investments, you really won’t find out if it was appropriate for you until after the fact.
Invest with vigilance.