Thinking about buying an annuity? When you sit with your insurance agent or financial advisor, you’re going to have questions. The most important ones are clear and are easy to answer. The agent should have answers on hand for all of them:
- How much will I receive each month when I retire?
- How much do I have to put aside each month to receive that amount?
- Is it better to choose a lifetime payout or a limited time payout?
- Can my family inherit my annuity?
- What is the annuity’s interest rate?
Those questions are clear enough. But there are a number of other questions that you should be prepared to ask as well.
Questions To Ask Before Buying An Annuity
How secure is the insurance company?
If you put your funds into a savings account and the bank collapses, the government will guarantee your funds. If you’ve saved up to $250,000, you’ll get all your money back. That isn’t true of the money you put into an annuity contract. No federal agency underwrites the funds placed in private annuity contracts. If the insurance company collapses a month before you begin receiving payouts your money will be gone.
In practice, that rarely happens. But it does mean that you should be wary of investing a lot of money with an insurance company that doesn’t have a good reputation.
Ratings agencies such as Fitch, Moody’s, and Standard and Poor’s grade insurance companies. So before you make that first payment, ask about the rating of the insurance company providing the annuity. Ideally, you’re looking for a rating of A++ or AAA depending on the rating agency.
Different agencies use different kinds of rates. Do make sure that the rating the insurance agent gives you is at least among the highest the agency provides. An ‘A’ from Standard and Poor’s is likely to acceptable; the same rating from AM Best is much riskier.
Ask for the insurance company’s rating—and ask the agent if they have a company with a higher rating.
What are the fees?
Annuities are expensive. You might find the idea of putting funds into an annuity every month now attractive. You’d reducing your tax bill, and get more money back in the future when your tax bill is lower. But the insurance companies do charge a lot for investing your funds for you.
In general, the fees for a fixed rate annuity are lower than those for a variable rate annuity. In addition, it is possible to customize your annuity contract by including riders. Those riders might include death benefits for beneficiaries or minimum payments for variable rate annuities. But each those riders makes the contract more complex and increases costs.
You can expect a rider to cost between 0.25 and 1 percent each year. You can expect the entire variable rate annuity to cost about 2.3 percent. Total fees could be as much as 3 percent.
That means that your returns have to earn enough to beat inflation and pay for those fees .
When your insurance agent presents you with a list of possible annuities, ask about the fees. Then compare contracts to see which company is charging the least.
What are the surrender charges?
In addition to the management fees, annuities also have surrender charges. When buying and annuity, this is key to know before you start. There are fines that you have to pay in order to pull your money out early. They can be very high indeed. Decide that you need your money before you reach the payout phase and you could find that you lose as much as 7 percent of your annuity.
That’s high enough to hurt and it underlines the fact that an annuity is a commitment to a long-term investment. Your assets won’t be liquid and you won’t be able to access them until the end of the accumulation phase.
You should know what the surrender charges are in case you find yourself with a sudden need for money. That knowledge will also ensure that you look for money everywhere but in your annuity.
How do the annuity’s returns compare to other investment vehicles?
This is a harder question to answer but it is still one that should you ask a financial advisor. Annuities aren’t cheap. The fees will be higher than buying mutual funds or Pension Plan, although mutual funds won’t pay you an income every month. But it’s important to remember that an annuity is just one investment vehicle among others. It has advantages (like a guaranteed income) and disadvantages (like high fees and surrender charges.)
Your financial advisor or insurance agent should be able to offer you alternatives with different kinds of benefits. It will then be up to you to decide how you want to balance the risks and returns . You’ll have to consider the the fees, accessibility to the funds, and tax issues, among other criteria. An annuity can be an excellent way to strengthen your financial future but it’s not the only way. It might not be the best way for you.
How will the annuity work with my other revenue streams?
In practice, your choice won’t just be between an annuity and some other investment vehicle. It will be what an annuity adds to your other investment vehicles. You’ll also have a 401(k). You might also have property investments. You could have mutual funds and money stashed away in savings accounts and in other places too.
An annuity won’t secure your future alone. It will work with your other investments to ensure that you have financial security once you’ve finished working. So you should know what it brings. What does it add to your pension payments, not just financially but in terms of security and tax benefits? Will it cover gaps between tenants if you’re renting out an investment property. How will it ensure that you always have an income? Can it deliver a level of security that your other investments don’t bring?
You won’t be buying an annuity in isolation. You’ll be adding it to a portfolio of other investments. Each of those investments will bring different benefits in terms of income stability, cost, tax benefits, and returns.
Ask your financial advisor how the annuity fits in the big picture.
Buying an annuity is a commitment. You won’t be able to pull your funds out quickly. You’ll pay more for your investments and you’ll have to crunch some difficult math. Understanding the formulas that will enable you to understand how much your annuity is worth won’t be straightforward.
You’ll also need to understand the difference between the different kinds of annuity and how they work for you.
But the benefits of an annuity make it well worth considering as another investment vehicle in your retirement portfolio.