The Top 5 Annuity Questions You Should Know; How to Answer Them

Updated on January 19th, 2022
Fact checked by John Rampton

John Rampton

John Rampton is an entrepreneur and connector. When he was 23 years old while attending the University of Utah he was hurt in a construction accident. His leg was snapped in half. He was told by 13 doctors he would never walk again. Over the next 12 months he had several surgeries, stem cell injections and learned how to walk again. During this time he studied and mastered how to make money work for you, not against you. He has since taught thousands through books, courses and written over 5000 articles online about finance, entrepreneurship and productivity. He has been recognized as the Top Online Influencers in the World by Entrepreneur Magazine, Finance Expert by Time and Annuity Expert by Nasdaq. He is the Founder and CEO of Due.... Read More

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Annuity Questions You Should Know

In today’s environment of financial uncertainty, having some form of guaranteed retirement income is especially appealing. For starters, you don’t have to worry about the stock market fluctuation or outliving your savings — the latter being a top concern when it comes to retirement. What’s more, knowing that you’ll have a guaranteed lifetime income gives your peace of mind and can make it easier to set a budget.

Moreover, you may also be receiving some regular income from Social Security, but it may not be enough to cover all your expenses. And, an annuity is a good option to boost your retirement savings if you aren’t fortunate enough to have a pension — which only around 21% of employees have.

However, despite these benefits, annuities can be challenging and complex. There are, after all, several types of annuities that have different fees and nuances as well as varying purposes. As such, an annuity might not be worth the investment if you don’t do your due diligence in advance.

With that in mind, here are five questions you have the answer to before committing to an annuity.

1. What is an annuity and how can it help me in retirement?

If you’re not familiar with annuities, then this is hands-down the first question to ask. And, here’s what I believe is the easiest answer.

Annuities are simply contracts between investors (you the customer) and insurers. You give an insurance company money, either as a lump-sum payment or as installments over a period of time. In exchange, the insurance company invests the funds so that you’ll receive a guaranteed series of payments.

In contrast to other insurance contracts, payments aren’t contingent upon an unfortunate event or accident occurring. The customer decides how they will receive their payouts rather than filing a claim.

No matter if you have a retirement plan or not, there are a lot of issues you need to consider. Again, perhaps the biggest concern of retirees is running out of income in retirement. However, according to SimplyWise’s Retirement Confidence Index, the number one worry for retirees is that Social Security will not be available when they retire.

But, that isn’t all. Another concern is the unexpected death of a spouse, high medical costs, and investments that are not keeping up. And, although there is no one-size-fits-all solution, purchasing an annuity and pairing it with other retirement income sources can help address these retirement concerns.

What an annuity should be a part of your retirement plan.

An annuity can play a crucial role in someone’s retirement portfolio as they can provide the following;

  • Protection and growth. With an annuity, you are able to grow your money without risking your capital.
  • Tax-deferral. Until the annuity payments are received, you are not liable for taxes.
  • Long-term security. Several insurers offer a long-term care annuity to cover these future costs in addition to providing supplemental retirement income.
  • Inflation adjustments. You’ll be certain to earn a real rate of return that’s either at or above inflation if you purchase an inflation-protected annuity (IPA),
  • Death benefits for heirs. You can pass on your annuity balance to heirs or spouses with an annuity that allows death benefit riders.

Furthermore, research shows that retirees with a guaranteed income live longer and are happier than those without.

2. What kind of annuity is best for me?

Again, annuities are insurance contracts. And, they can serve a variety of purposes. Some may be used for retirement investments, while others can serve as a way to prevent outliving your assets. Additionally, there are three main types of annuities: fixed, indexed, and variable.

  • Fixed. These are pretty straightforward. In a fixed annuity, the person who signed the contract receives periodic payments. Investors who purchase fixed annuities will be guaranteed a fixed return. And, during the contract period, they offer a fixed rate of return.
  • Indexed. With this type of annuity, the interest rate is determined by a particular index, such as the S&P 500. Rates of interest growth are fixed by the insurer. A complex feature of equity-indexed annuities is the number of ways insurers calculate the index return.
  • Variable. Your balance and payments will be affected by the market’s performance. Variable annuities can be compared to individual retirement accounts (IRAs). Each offers tax-deferred investment growth through retirement savings accounts. As soon as you start receiving payments, you will have to pay income taxes at your marginal rate.

Also, these annuities can be either immediate or deferred. With an immediate annuity, you can withdraw your money, well, immediately. But, if it’s deferred, you’ll receive payments at a future date.

Which one is right for me?

“Short answer: it depends,” Matt Rowe writes in a previous Due article. What matters is when you want the payments, how much assurance you need, and how much risk you’re willing to accept.

“The majority of people seeking one will generally go with immediate annuities,” he adds. “If your first concern is having an income stream you can’t outlive, an immediate annuity may be the best option for you.” What if you’re a planner and expect to live a long, healthy life? Then deferred annuities might be the right choice for you.

“Of course, you’ll have to set up the account prior to actually getting the payments, although you’ll have peace of mind,” Rowe states. “Immediate, deferred, and fixed annuities will be best for those wanting to play it safe.”

Variable annuities may be the best option for you if you’re willing to risk some volatility. Finally, fixed index annuities are ideal for those who have some time before they really need income. With fixed index annuities, you can realize higher profits without risking your capital.

“At the end of the day, it depends on your needs and situation,” he explains. “If you’re shooting to play it safe, go with immediate, deferred, fixed, and fixed index annuities. If you are willing to take some risk, go with the variable annuities.”

“It may be best to talk with a financial professional at Due.com to see which is best for your situation.”

3. How much does an annuity cost?

How much an annuity will cost depends on what kind you consider. Just note, though, that regardless of the type, annuities aren’t cheap. With that said, payout annuities and fixed indexed annuities do not charge specific fees. Fixed-rate annuities, in general, have lower fees than variable-rate annuities.

So, why are annuities so expensive? Well, perhaps the most obvious cost is commission fees.

The inclusion of commission fees isn’t clearly stated in most annuity contracts. Nevertheless, they can range anywhere between 1% and 10% of the total contract value. And, how your annuity flows depends on how it is structured.

  • Annuities with a single premium often come with a commission of 1% to 3%.
  • Deferred income annuities typically range from 2% to 4%.
  • A commission on a 10-year fixed annuity typically ranges from 6% to 8%.

In addition to commission fees, you may also have to take into account the following costs;

  • A rider is a customized feature that you can add. For example, death benefits or minimum payouts are common riders. Usually, each rider costs between 0.25 and 1% a year.
  • An administrator’s fee is what you pay to manage your annuity, usually around 0.3% of the contract’s value. A flat fee of around $30 may be charged, however.
  • A mortality expense risk charge is equal to a certain percentage of your account value, usually 1.25% a year. This is the risk that the insurance company has taken in selling you an annuity contract.
  • The underlying fund expenses cover any costs associated with the management of the underlying mutual funds.
  • A surrender charge and a tax penalty may apply if you sell or withdraw your annuity too early or before reaching a certain age, usually 59 ½.

4. Is annuity income truly guaranteed?

“Annuities can offer many choices for guaranteed income,” notes Craig Hawley, head of Nationwide Advisory Solutions. This includes “the simplicity of an immediate annuity to a range of different optional living benefit riders that are designed to protect portfolio assets or income payments when markets decline.”

In some cases, living benefits provide guaranteed income regardless of the performance of underlying investments. In addition to the Return of Premium option (ROP), investors may be able to purchase a guarantee on their initial investment as another way to protect themselves against market risk.

An annuity is a contract with an insurance company, so the payment guarantee is dependent upon the financial strength of the insurance company. “Insurance companies are highly regulated, with strict requirements related to their investments and capital reserves,” adds Hawley.

“Their financial strength is regularly reviewed and rated by five independent firms: A.M. Best, Fitch, Kroll Bond Rating Agency (KBRA), Moody’s, and Standard & Poor’s, each with their own rating scale and rating standards.”

Furthermore, each state has a Guaranty Association that serves to protect policyholders in the event the insurance company becomes insolvent. “

A study by the U.S. Government Accountability Office determined that even following the profound effects of the 2008 financial crisis, the impact on the majority of insurance companies and their policyholders was limited, with a few exceptions,” he states.

5. How do the annuity’s returns compare to other investment vehicles?

Financial advisors are the best people to answer this question? Why Because it’s more complicated than it seems. But, let’s give the old college try.

As I’ve already mentioned, annuities aren’t cheap. Compared to mutual funds and pension plans, the fees will be higher. Mutual funds, however, will not pay you a monthly income. It is important to remember that an annuity is just one investment option among many. In addition to having advantages, such as a guaranteed income, it has disadvantages, like high surrender fees.

An insurance agent or financial advisor should be able to offer you options with different types of benefits. From there, the balance between risks and returns is then left up to you. Other criteria to consider include the fees, the ability to access the funds, and tax implications.

Overall, purchasing an annuity can be a great way to protect your financial future, but it isn’t your only option. In some cases, it may not even make sense to buy an annuity. But, answering the questions above can help you make this important financial decision.

Deanna Ritchie

Deanna Ritchie

Deanna Ritchie is a financial editor at Due. She has a degree in English Literature. She has written 1000+ articles on getting out of debt and mastering your finances. She has edited over 40,000 articles in her life. She has a passion for helping writers inspire others through their words. Deanna has also been an editor at Entrepreneur Magazine and ReadWrite.

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