Have you ever gone car shopping? Even if you aren’t a car enthusiast, most people know that the vehicle should have basic safety features, like antilock backs and airbags. Most of us would also enjoy features like power windows, heat and air conditioning, comfortable seats, and some sort of audio system.
From there, however, you can narrow down your search by the engine and transmission type, hauling capacity, and if you prefer front-wheel or rear-wheel drive. And, you might even consider features like Bluetooth capability and if you can start the vehicle remotely.
TL;DR, there are a lot of features for you to think about when buying a car. And, this is also true when it comes to annuities.
Annuity Basics
For a lot of people, annuities can be complex and intimidating. It’s like getting overwhelmed by tech-filled automobiles containing features from touchscreen dashboards to semiautonomous driving. But, once you learn more about the vehicle and take it for a test drive, you might not feel as overwhelmed.
That’s kind of the case with an annuity. They’re not as complicated as you may believe. Most annuities are relatively straightforward. So, with that in mind, let’s quickly go over the basics of annuities to make you feel more comfortable with them.
The purpose of an annuity is to help shield you from the risk of outliving your income. How so? Well, in exchange for either a one-time payment or a series of payments to an annuity company, you’ll receive a guaranteed income stream. Often, this is a contract between you and an insurance company.
Classifying annuities.
Now, here’s where things start to heat up. Annuities, just like vehicles, come in a variety of categories. These include;
- Whether the underlying investment is fixed or variable, you’ll have a guaranteed rate of return with a fixed annuity. In addition, a fixed-rate of return is offered for the length of the contract. The performance of the market affects your balance and payments with a variable annuity. It’s similar to an individual retirement account (IRA).
- Is the primary objective accumulation (deferred) or pay-out (immediate)? In other words, do you want to receive payments in the future, or do you want your money right now?
- The duration, amount, or lifetime of the payout commitment. You can either receive payments for life or for a specific period of time, like for 20 years.
- Qualified or nonqualified tax status? The funds used to purchase qualified annuities are pre-tax, while money used to fund non-qualified annuities has already been taxed.
- Arrangements for payment of the premiums. A premium is an investment you make in the annuity plan and company. You may make the investment in one lump sum or over time. What’s more, you can make ongoing premiums after the initial investment.
It’s possible to classify annuities in more than one of these categories. For example, you could buy a deferred variable annuity that is nonqualified or an immediate fixed annuity.
10 Must-Have Annuity Features
Now that you’re not as hesitant about getting being the wheel of annuities, let’s hone in on the must-have features your annuity should offer.
1. Guaranteed income.
With an annuity, you can have recurring payments for the rest of your life or for a predetermined specific period of time. In turn, this reduces the risk of outliving your savings if you have a reliable income stream along with 401(k)s and Social Security. During the post-pension age, this is a significant advantage.
An immediate annuity will convert an investment into a stream of payments for the rest of the owner’s life. Payouts come from three different sources:
- The original investment;
- Investment earnings;
- According to actuarial tables, a group of investors who are not likely to live long.
This pooling allows annuity companies to ensure a lifetime income, and it’s arguably the most unique feature of annuities.
2. Premium options and protection.
Generally, you have three options when it comes to paying for an annuity, depending on the type:
- Single premium payments can be made for both immediate and deferred annuities. Single-premium annuities are often purchased with cash from a retirement plan, savings account, life insurance policy, or home sale.
- In a deferred annuity, you have the option of making periodic payments of the same premium amounts at regular intervals until the payouts are to begin. Or, you can make periodic payments of a variable premium amount over a certain period of time.
Having premium options allows you to choose the right annuity for your financial situation. Also, your annuity should also provide premium protection, meaning that you can’t lose the amount you initially invested.
3. The ability to defer tax on investment income.
While many investments are taxed annually, investment earnings, like capital gains and investment income, in annuities are not taxable until the investor withdraws the money. As with 401(k)s and IRAs, annuities also defer taxes. However, unlike these retirement products, there are no limits to how much can be invested.
In addition, annuities require a much lower minimum withdrawal requirement than 401(k)s and IRAs.
4. Unlimited contributions.
In general, there is no limit to how much money you can invest in an annuity after taxes, regardless of your income level. In other words, there shouldn’t be any annual limits on how much money you can contribute to an annuity.
This gives annuities a huge advantage over 401(k)s or IRAs, which have contribution limits. In 2021, the maximum contribution you can make to a 401(k) was $19,500, or $26,000 if you are over 50. In 2022, the number jumps to $27,000 for those over 50 and $20,500 for those under 50. A Roth or traditional IRA can hold up to $6,000 in 2021 and 2022. For those over 50, the limit is $7,000.
5. There is a wide range of investment options available.
Look for the various investment options that many annuity companies offer. Like a bank CD, a fixed annuity credits a specified interest rate to its investors. Due, for instance, pays a three percent interest rate on your money — guaranteed.
You can invest your money in stocks, bonds, or mutual funds with a variable annuity. Annuity companies have been creating “floors” to limit the extent of investment declines from a reference point of increasing growth.
6. Death benefits.
There should be death benefit protection on most annuities. That means upon your death, the amount you contributed will be distributed to your beneficiary, minus any withdrawals you’ve made. The death benefit you receive from a variable annuity is either the account value, less withdrawals, or the amount you paid in premiums. This will be whatever is greater.
In each annuity contract, these benefits are outlined. And, you should clearly understand them before signing the contract.
7. Living benefits.
While most annuities provide a stream of income that cannot be outlived, they offer optional principal protection benefits for an additional cost. These benefits, known as living benefits, provide financial protection against the impacts of market declines on your account value or future earnings.
Many insurance companies step up the benefit amount by a defined percentage or by the contract value on specific dates. For example, a benefit may be determined by the highest contract anniversary value. You could also compute it by taking your annual purchase payments (less prior withdrawals) compounded at 3% per year.
- Guaranteed lifetime withdrawal benefit (GLWB). If the contract value decreases below zero, you will receive a return of your purchase amount (loan payments less prior withdrawals) through annual withdrawals for a specified period or for life.
- Guaranteed minimum income benefit (GMIB). Regardless of how the market moves, this benefit guarantees a minimum income level in the future.
- Guaranteed minimum accumulation benefit (GMAB). No matter how investments perform, this benefit guarantees a minimum future balance.
8. Tax-free transfers between investment options.
Owners can change how their funds are invested with annuities without incurring tax consequences, unlike mutual funds and other aftertax investments. This is particularly valuable if you’re using a rebalancing strategy. By rebalancing, investors return their investments to the proportions that best match their risk/return objectives.
Also, thanks to something known as the 1035 Exchange, you’re permitted to change one annuity for another without facing penalties. Why would you do this? Well, if the performance of a variable annuity has been fluctuating and you’re approaching retirement, you could swap this for a more consistent fixed annuity.
9. No mandatory withdrawals.
You do not have to take required minimum distributions after 72 if your annuity is not part of an IRA or qualified retirement plan.
10. Log-term care.
Did you know that 70% of people 65 and older will require long-term care? More concerning? The national annual median cost of care for a private room in a nursing home is $102,000. As if that weren’t bad enough, long-term care services have been increasing since 2004.
How can you address this concern? First, obtain a long-term care annuity.
Considered a hybrid policy, “a long-term care annuity, which provides long-term care insurance at a multiple of the initial investment amount,” explain the folks over at Fidelity. “The investment grows tax-free at a fixed rate of return, and, if used for long-term care expenses, gains will be received income tax-free.”
When you qualify for long-term care benefits, the long-term care coverage will reduce both the account value and the long-term care pool, they add. When the value of your account is exhausted, the insurer will provide the remaining long-term care pool benefits, which is effectively the insurance component of your policy.
“However, today’s low-interest-rate environment has made it challenging for insurers to provide annuities with long-term care coverage,” they state. “So, it’s important to note that these products have yet to gain any significant traction in the market, and, as a result, may not be available through your insurance company.”
Typical Annuity Fees
While the features listed above can make an annuity appealing, one major knock against them are the fees involved. If you aren’t aware of them, they can be expensive. So, what fees are we looking at here?
Well, regardless of the annuity type, you can expect commissions — usually 1 to 10 percent of the total value of your contract. After all, the person who sold you the annuity has to put food on the table. However, you may be able to find a no-load annuity. Because some financial institutions and insurance companies directly sell these, there aren’t commission fees.
You should also be aware of penalties and surrender charges. Often, these will be applied if you make an early withdrawal. For example, if you’re under the age of 59 ½, the IRS will impose a 10% penalty. In addition, if you sell part or all of your annuity before payments begin, the annuity company will charge you a surrender fee.
Different types of annuities will have distinct fees outside of these general annuity fees.
Immediate annuity fees.
Standard fees often don’t apply to immediate annuities. However, annuity owners should be aware that they may have to take a drop in income distributions if the payout is more generous. Also, note that single premium immediate annuities may also carry a commission.
Deferred income annuity fees.
Deferred annuities, also known as longevity annuities, do not charge fees either. However, when payouts are in your favor, your income distribution amount will be reduced. These annuities come with commissions as well.
Fixed annuity fees.
Fees on Fixed Annuity contracts will be based on lowered interest rates.
Fixed index annuity fees.
You are responsible for annuity rider fees if you own a fixed index annuity. However, adding these features to your contract is optional. Enhancing the death benefit or increasing the cap rate are a few examples. Fees are not uncommon to cost as much as 1.75 percent of an account’s value. But this varies by benefit.
An annuity company offering an optional upsell is an example of this. Unlike the standard non-fee option, this rider gives you more potential upside to your contract.
However, be cautious with these fees. You may have to pay an annual fee for some riders or benefits that are “built-in.” This may be true regardless of whether you want it or not.
Variable annuity fees.
Among all annuity types, variable annuities can be the most expensive. The reason is that variable products come with higher fees. Sounds unfair, doesn’t it? But, variable annuities are investment products rather than solely insurance products.
As a result, here is a list of the typical investment management fees you should expect to pay if you own a deferred variable annuity investment.
- M&E (Mortality & Expenses): M&E provides death benefits for your heirs. An investment fee of up to 1.5 percent of the value of your account can be charged.
- Administrative Fees: The annual fee for maintaining ownership of your contract is up to .30 percent of the contract value.
- Investment Expense Ratio: The stocks and bonds you select for your variable annuity account, also known as a subaccount, will be subject to an advisory fee. You can expect to pay up to two percent of the total value of your annuity annually.
- Guaranteed Lifetime Withdrawal Benefit: Fees for income riders are similar to those for index annuities. Typically, a percentage of the account value is charged annually.
- Enhanced Death Benefit Riders: You can purchase an optional estate planning rider to protect your beneficiaries’ investments. Annually, the cost can be high, usually up to .50 percent of the account value.
Each type of annuity has a different fee structure. Thankfully, most annuity carriers are transparent regarding the features of their product, as well as what it will set you back initially.
In short, you don’t have to lose sleep over any “hidden fees” being included in your contract.
