If used properly annuities can be purchased to protect assets or replace the safety that some bonds often provide. They are sometimes used to provide a guaranteed stream of income, like pension plans and social security.
Let’s explore the definitions: An annuity is a contract issued by an insurance company and often offered through insurance agents or a properly licensed financial advisor. Insurance agents are usually allowed to offer indexed or fixed annuities only, while a FINRA or SEC licensed advisor may direct you towards what’s known as a variable annuity contract.
What are the four basic types:
Immediate annuity
Similar to a Pension or Social Security, you would trade a lump sum of cash for a guaranteed income either for a certain period of time or for the duration of your life.
Pros
- You never worry about market fluctuation and will have a fixed income for a predetermined period of time.
Cons
- An annuity could potentially expire before you do. You also give up the opportunity to potentially grow the assets or income.
- At death it is likely the insurance company would keep any unused funds, meaning they may not be passed on to your spouse or estate.
Fixed Annuity
Pros
- No market fluctuation.
- Backed by the full faith and credit of the insurance company.
- In most cases your principle is guaranteed.
Cons
- Rates tend to be low.
- Beware of contracts that offer rates higher than normal or bonus rates.
- There can be significant exit penalties, if you cash the contract in early.
- The rates may not be fixed for the entire term of the contract.
equity indexed annuity
This is an insurance product that’s often sold as an investment that mirrors the S&P 500 index without risk or cost and this is simply not true. An indexed annuity may provide a lifetime income but in many cases you are doing nothing more than receiving your own money back for an extended period of time, plus a modest interest. Once the accounts goes to $0 the annuity company may offer a rider that allows you to extends the income over your life.
Pros
- This contract may provide you with a lifetime income.
Cons
- There is often not a cost-of-living increase in the income.
- They are often sold as a way to participate in the stock market without any risk or any cost. One must be careful is this is frequently deceptive advertising or sales tactics.
- Indexed annuities frequently charge high commissions. Often sold through free dinner seminars. Indexed annuities can keep a salesperson commission as high as 15% of the amount invested.
- Exit penalities can be expensive and last for long periods of time.
- To sell an equity indexed annuity requires the sales person to only have a life insurance license. No investment advisor licensing is required.
Variable annuities
Can only be offered by a properly life licensed financial advisor with a FINRA or SEC license.
Pros
- They offer legitimate access to multiple different investment products and strategies.
- They often offer favorable guarantees, income and death benefits either built-in or as riders on a base product.
- Manageable exit periods
Cons
- They are likely at the upper scale of expenses as they should be. While offering the benefits of investing in Mutual Funds and ETF's, the insurance company takes on most of the downside risk of investing.
Overall a variable annuity can be a welcome addition to a retiree’s portfolio that is looking for the additional stability and in some cases the tax deferral that these investments offer. Contact us if you currently have an annuity and would like a second opinion on its viability or if you’re considering purchasing an annuity as part of your portfolio. Our experts will be happy to guide you on your decision, please use extreme caution prior to investing in any annuity product.