Who Should Buy Annuities

Annuities can be a very stable investment vehicle that provides an immediate income stream or deferred tax benefit that wise investors crave. In fact, annuities deliver an easy way to develop retirement accounts that are able to grow tax-free until a withdrawal is made, providing predictable income in the future. Therefore, any investor who is seeking to create a diverse portfolio that accumulates funds and tax-free for future income streams should consider purchasing any number or varieties of annuities.

A prudent among for those planning on retiring or those already in their retirement years, annuities are popular contracts that promise to make periodic payments to the investor for a specific period of time and for a specific level of interest. This level of predictability helps calm fears of market swings. Of course, the amount of those return payments ultimately depend on the amount of money initially invested, the type of annuity chosen, the length of time that has passed, and the performance of the market.

Sold or backed by an insurance company, there are various types of annuities that exist and all with slight variations that may appeal to each investor, depending on his aversion to risk and financial goals. For example, variable annuities allow the investor a little bit of control at where to place his or her money. The investor may elect to place a percentage of that money in a higher risk fund as well as an index or bond fun. Similarly, an investor may elect to place funds in an indexed account of which the performance is tied to the investor.

On the other hand, fixed annuities for example, offer a predetermined rate of return of say 4%. This may be lower than the market growth over several years, but it is enough to keep pace with inflation, and it provides the average investor an opportunity for moderate income growth that is tax free. During the ebb and flow of the market is bound to occur from time to time, those investors who have place some of their earnings in fixed annuities will maintain a steady stream of income and negate much of the financial losses that traditional stocks may experience.

With annuities, the investor can get his funds back when he retires in a percentage that is entirely based on his discretion and on his fluctuating needs from year to year.

Further, he can either elect to be paid out all at once in one lump sum or in installments for period of time, say 10 to 30 years. For example, an investor can, at the age of 65, decided that he will withdrawal 7% a year for the next 25 years from his account. The longer the investor waits to make good on those withdraws, the more percentage or amount he would be able to take each month.

Building retirement income through various annuity accounts can create periodic paychecks that the investor knows will be there for a particular time period. A portfolio with several annuity accounts can all have various distribution or pay days that can supplement other investments the investor has made. With the predictable fluctuations in the market, fixed annuities generate the attention of conservative and frugal investors who would like to foresee a steady and dependable rate of return.

What Are the Risks of Owning Annuities

As with any investments, annuities pose certain risks to the investor. Depending on the annuity, the level of risk can decrease or increase. The level of risk is contained within two general factors: the type of annuity it is and the solvency of the company issuing the annuity itself. Annuities aren’t the typical savings vehicle issued at a bank, for example. Rather, annuities are contracts purchased by an investor from an insurance company in exchange for payment on a specific date, over a specific period of time, and usually at specific rate of return.

It is important to note that annuities are not backed up by the FDIC and some may not be registered with the SEC.  However, certain states may have special annuity coverage funds if the company issuing the annuity goes under through “guarantee associations.” The amount of coverage varies depending on which state you live in. For example the state of Washington seems has the highest protection of $500,000. If the insurance company which the annuity was purchased from is not able to cover their obligations, usually other insurance companies step in and buy out the company and redeem some of the investments. This practice preserves the health of the entire industry.

A fixed annuity is a contract that determines a specific rate of return over a particular period of time. The level of risk may be considered lower than other annuities because its health is not necessarily based on market fluctuations, but rather more stable insurance pools. The drawback for some investors is that the Rate of Return for fixed annuities is not as dramatic as other investments.  A variable annuity on the other hand, allows the investor the ability to determine the level of risk.

By allowing the investor to determine the percentage of his payments into subgroups, the risk can either increase or decrease. For example, if you decided to purchase a variable annuity and place 75% of your payments into a higher risk mutual fund and the rest into a lower risk fund, the overall risk of that annuity may increase. The level of return would ultimately depend on the performance level for each of those funds chosen as a percentage of your portfolio. Variable annuities also allow you to invest a percentage of the funds into a fixed mutual fund as one would in a traditional fixed annuity account. This provides an increase level of freedom for the investor to diversify his portfolio.

Specifically, index annuities are based on the overall performance of the market. The level of return would essentially be based on whether the market goes up or down and would intrinsically have a more risk than a fixed-deferred annuity or a variable annuity. Yet, as other annuities, index annuities can provide good long term investments if we consider the historical levels of market performances that trend upward through the years.

With any financial instrument, a level of uncertainty will always exist. However, the amount of risk which is expected with annuities depends on the type of the annuity chosen by the investor and also includes the long term stability and health of the insurance company the investor is making the purchase from.

Nevertheless, seasoned investors find annuities as attractive saving instruments because they can survive through significant market upswings relatively unscathed, falling interest rates, and deferred tax obligations determined on any earnings due to interest over time. The best way to understand the risk associated with each annuity is to thoroughly read the issuing company’s prospectus.

Indexed Annuities Explained

Annuities are contracts that are purchased by investors from insurance companies in exchange for promise of future payment. There are several annuities which exist, including variable, fixed, and indexed annuities. Like other annuities, indexed annuities can provide several key benefits to investors including a way to defer taxes and increase the amount of their initial investments.

Index annuities offer features that are unlike other annuities offered as they are specifically linked to the performance of the market as a whole. Since the rate of return for the investor relies on the performance of the index market, it is possible for the investor to ultimately get less in return than what he actually paid into the annuity – again, depending on the terms of the contract and the market. However, if the market performs above average, the investor also gets to realize that growth year after year without having to pay any taxes on that growth until he makes his first withdrawal on the account.

As with other annuities, this can provide an excellent way to increase future retirement income and defer any taxes. As always, an investor should review the contract features of the indexed annuity they purchase, as these investments may or may not be registered with the SEC. Generally, for SEC registered indexed annuities, the investment must provide a minimum rate guarantee of return for the investor. Due to the inherit nature of this time of annuity and the typical market fluctuations, this is not always guaranteed. Nevertheless, index annuities provide a certain option for those wanting to invest and diversify their portfolio to an instrument that is linked directly to the performance of the market.

Since annuities are not guaranteed by the FDIC, as other bank accounts are, investors who purchase annuities should be aware of the inherent risks due to the volatility of the market. Due to the fact that index annuities may particularly sensitive to the market’s performance, an assessment of risk should also be made on the stability and solvency of the issuing insurance company.

As with other savings vehicles, the investor should know several key features to the index annuity before entering the contract with an insurance company, such as the rater of return, and margin fees (sometimes referred as administrative fees).  These fees can take a take a chuck of the annuity growth during the distribution phase.  An investor would be wise to ask either his insurance agent what those margin fees would be. For a typical indexed annuity contract, the margin fee might be 2% or 3%. This fee is justified by the insurance agent as an “administrative” fee to maintain the account. Nevertheless, it could chip away at the investor’s earnings.

With index annuities, there may also be ceilings or the maximum rate of interest imposed in the contract which can be earned by the investor. These ceilings could significantly reduce potential earnings for the investor. Take for example the interest rate ceiling for an index annuity contract is set at 10%. In addition, let us assume that the market grows 15% over a lifetime of the annuity for 25 years. According to the contract ceiling, the investor would only be entitled to the 10% minus the 2% margin fee. In the end, he may only be entitled to 8%. It is therefore in the investor’s interest to ask about all fees with any annuity he or she purchases – including the administrative fees.

Can Annuities Be Rolled Over

There are many benefits that annuities provide for investors, including tax savings, predicable income growth, and flexibility to roll over into other accounts. If you have an annuity or several of them which were first offered from your employer you may be in the position where you need to switch providers. For example, let’s say you are changing jobs, or you simply would like to make a switch to an existing annuity provider to another for any reason, you can do so.

Let’s take a familiar example: You work for Company X who provides you the ability to contribute to your annuity through a particular company. You have decided to relocate and change jobs in a different state. Company Y offers you the opportunity to contribute to an annuity using yet another annuity company. There are certain benefits to switching. You may be able to continue contributing to your annuity and having it grow as you move further into your career and continue to receive the benefits of tax free growth.

The IRS rules allow you to make a switch, but you to do so there may be some things you have to do on your part so that at the end of the year, you can stay clear of the tax man.  The first thing you want to make sure you do is not confuse your accounts by keeping a different account for those accounts you roll over. So if you were to switch providers, you would not simply divest the funds from the account and place them into new accounts with your provider. Think of it as keeping your pots separate even though you are moving into a different house. If you dump your funds in your pot into other pots that exist, this could lead to a bit of confusion when tax time comes. The confusion gets a bit worse if the money in the pot isn’t already tax deductable.
The next thing you want to be sure of is that you directly roll it over from one annuity provider to the next. Taking the money out of the pot and holding it in your pocket – even for a moment, could land you a nice penalty with the tax man. Instead, contact your annuity customer service tell them what you are planning to do and which company you are planning to switch to. They will have you sign some paperwork and should take care of everything for you. Doing directly this way allows you to avoid any penalties.

There are other types of roll over or exchanges that can occur on non-qualified annuities that you can take into rolling it over into another “non-qualified” annuity. These 1035 (IRS code) exchanges allow you to make the change and preserve your tax benefits. Again, you want to move your funds within these annuities from one company to the next directly – without you ever coming in the middle. This will provide you the ability to not pay taxes on the early withdrawal. Before continuing with a rollover, look up the latest fixed annuity rates to make sure you getting the best deal.

In addition the IRS rules allow you to exchange or rollover different types of annuities as you make the change. For example, let’s say you are with company X and have fixed annuities and moving to Company Y where you would like to switch to variable annuities.

Rolling over your annuities can be done easily and with careful planning does not have to incur a tax obligation, early withdrawal penalties, and high transfer fees.

5 Things to Ask Your Annuity Agent

Annuities are investment contracts between the investor and the insurance company, but are often sold by an annuity agent. An annuity agent can be helpful because he or she can offer many different annuities from several different companies that offer you a variety of rates and options than you would otherwise receive from going directly to one company.  To make the most of the relationship with your annuity agent, there are five things you should consider asking:

Is your agent able to sell?

First things first, let’s make sure your agent is legitimate. Most states require your agent to be registered and have a license to sell annuities. If you walk into his or her office or whether your agent comes to you, you should ask if they are licensed to sell annuities in your state. Yes, it could be awkward, but so is losing all of your money to someone who does not know how to invest. Most agents understand that a level of trust needs to be established between the two of you and will not mind showing off their hard-earned license. Making sure your agent understands the basics of what he or she is selling and the laws and regulations is the prudent thing to do for every investor. Working with licensed agent guarantees you further protections.

What kind of commission is your agent making off the transaction?

Agents are also in the business of making money and you should expect that they get a commission for each account that they open. However, you should know what the arrangement is between them and the companies they represent. Understanding what they get with the purchases you make is essential to understand their motives of selling to you. Transparency is essential to all successful business relationships and partnerships. Often, the best deals are had with an independent agent because they have a less chance of being biased towards any one annuity even if it lacks the benefits given by another.

What annuities can they offer you?

Agents are in the business of offering annuities from various companies. You should expect that several different types of annuities coming from various companies can be made available to you. If your agent can only offer you a few annuities from only one company, consider that you may not be getting the best deal. The wider your options, the better decisions you are able to make with regards your investment; knowing the potential growth, the risks involved, and the fees and penalties you may incur based on present or future behavior is essential.

Understand your fees:

An agent should be able to answer all the fees, including penalties, transfer, or withdraw fees for your annuities and explain them to you in an easy way. Often times, an agent will have “surrender fees” which can put you in a pinch when you are interested in switching agents or annuity providers. Often times, these fees drop off or decrease as the years go by. Find out how the percentage the fees decrease per year.

What are the ratings of the insurance company that will issue your annuity?

If your annuity agent is worth his salt, he will be able to tell you the ratings of the insurance company you are making the purchases from. Since, annuities are not back up by the FDIC like the funds in your bank account are. The important thing to remember is that your money is only backed by the health and solvency of the issuing insurance company. Understanding the ratings can give you a better picture at the health of the company and the future of your investment.