Wednesday, March 15, 2023

Annuity Myths and Facts

An annuity is a contract between an investor and a life insurance company. Annuities are sold by insurance agents, stock brokers, and other financial advisors. The annuitant, who is usually (but not always) the owner of the annuity, pays a lump sum amount or makes deposits over time and the insurance company promises immediate payments or payments at a future date.

Below are some key things to know about annuities from a recent seminar that I attended:


Complexity- Annuities are often sold as a “simple” investment but, in reality, they can be quite complicated. Annuity salespeople sometimes convince people there are no fees but, of course, there are. Examples include surrender charges, sales commissions (loads), management fees, and mortality charges.


No Federal Insurance- There is no federal government insurance for annuities as there is for bank products (FDIC) and investment products (SIPC). Therefore, credit quality of issuing insurance companies is very important. Look for an issuer that is highly rated by at least two insurance company rating firms (e.g., A.M. Best, Duff and Phelps, and Standard and Poor’s).


Three Types-Fixed annuities are like CDs, only tax-deferred, and guarantee a certain interest rate for a specified time period. Variable annuities are like mutual funds, only tax-deferred, and their owners select underlying mutual funds, called subaccounts, which determine an annuity’s performance. Equity-indexed annuities tie a portion of their return to a stock market index such as the Standard and Poor’s 500. Generally, variable annuities have the highest fees.


Two Time Categories- Immediate annuities begin payment within a year of purchase. They are often bought with money from settlements, investment accounts, and pension plan lump sum distributions. Deferred annuities make payments at a future date and allow annuitants time to make deposits. Either type provides a guaranteed income stream subject to contract terms.


What Not to Do- Annuities are generally not appropriate for qualified retirement plans such as 401(k)s or IRAs. They are already a tax-deferred product and investors gain no benefit by placing them in a tax-deferred plan. In addition, many annuities have high expenses, making them a less attractive alternative to low-cost investments such as index funds and ETFs.


Income Taxes- Earnings on annuities are tax-deferred until annuitants make a withdrawal, generally during retirement. At that time, withdrawals are taxed as ordinary income, minus the amount of after-tax dollars originally used the purchase the annuity.


Reasons to Purchase- The attorney presenter noted the following reasons to consider an annuity as part of overall estate and financial plans: 1. Medicaid planning, 2. To convert life insurance policy cash value into income and stop making premium payments, 3. For a guaranteed lifetime income stream, and 4. To dole out money to a spendthrift adult child.


In summary, annuities are a financial tool to consider...when they make sense. 

Look for highly rated, low-expense vendors.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

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