Broker Check

It Pays to Understand Annuities

January 30, 2017

Annuities are a very popular retirement tool. Since they are contracts with an insurance company, they can sometimes be complicated. Here are 8

Tips to Find the Right Annuity

When you reach a certain age, you are likely to get invitations to hear about LIFETIME INCOME plans that include a nice dinner and a sales pitch for a product, usually an annuity. The products often sound really great. And for many people, the idea of having SOME of their retirement money guaranteed not to go down, is very appealing.
But too often we get excited about a product that solves a problem, before we have taken the time to understand our own personal BIG PICTURE. Most people will benefit from a comprehensive financial game plan to provide a secure roadmap to comfort and security in their retirement years. A great guide on the journey is a fee-only, fiduciary, financial planner who is your advocate to help you reach your goals. They can help you lay out a plan based on your goals and current situation.
Sometimes your financial plan reveals a need for a source of guaranteed income to cover a portion of retirement needs. This can be a great fit for an annuity. Here are eight tips to find a good annuity for you.

Tip #1: Does an annuity fit in the first place?

  • Do you want or need to defer income tax on growth of some of your savings?
  • Do you need additional income to cover fixed living costs in retirement?
  • Would you like to lock in income for as long as you -- or you and your spouse -- live?
  • Can you lock up a portion of your savings in exchange for a guaranteed monthly check?

Tip #2: Be clear on your needs

  • Can you let the money grow in the annuity, or do you need income right away?
  • Are you looking for growth of principal or guaranteed income?
  • Do you need income for one person or do you need the income to continue until the second spouse dies?

Tip #3: Understand the terms

  • Fixed annuities pay interest on principle at a fixed rate for a fixed period of time.
  • Variable annuities include sub-accounts of mutual funds that own various investments like stocks and bonds. They have the potential to grow with the stock market but there is not typically a guaranteed return.
  • Immediate annuities begin to pay income as soon as the contract is issued. This product allows you to exchange a sum of money for a guarantee of monthly payments for a stated period of time.
  • Deferred annuities are designed to grow tax deferred for a time and then begin income distributions at a later time.

Tip #4: Understand the basics

  • Annuities are issued by an insurance company and backed by the company's ability to pay.
  • You pay premium dollars into the contract after tax.
  • Earnings accumulates tax deferred.
  • Earnings are taxed as regular income when distributed.

Tip #5: How to feed your annuity.

  • You can make a one-time investment.
  • You can make a series of investments over a period of time.

Tip #6: Guaranteed death benefits.

This is an optional rider on most contracts that can protect the principal after the owners death. Often these riders add a small amount to the annual expenses of the contract, and in exchange, they promise to pay your beneficiaries at least the total of all premium payments made less any distributions.

Tip #7: Know the cost

It's important to understand the fees and expenses your annuity contract will charge against your account.

  • Fixed annuities will sometimes have an annual contract fee.
  • Variable annuities will usually have
  1. Annual contract fee.
  2. Mortality and expense charge to provide for the death benefit.
  3. Investment subaccounts will have investment fees, expenses and operations costs.
  • Both will often have a surrender charge if you try to remove money from the annuity in the first years you own it.
  1. Often surrenders last as many as 10 years.
  2. Typically the first year surrender charge is about equal to the number of years that charges will apply. For example.
  • 6% surrender charge, year one.
  • 5% surrender charge, year two.
  • 4% surrender charge, year three
  • 3% surrender charge, year four
  • 2% surrender charge, year five
  • 1% surrender charge, year six
  • After 6th anniversary, no surrender charge on distributions.
  • Often tax-qualified annuities will provide for required minimum IRA distributions free of any surrender charge.

Tip #8: Know how you can get money out

  • Annuities get tax advantages as a retirement vehicle, so distributions prior to age 59 ½ will be subject to a 10% IRS penalty on earnings.
  • Distributions are considered earnings first, then premiums. Distributions of earnings are taxed as regular income when received.
  • Some contracts offer guaranteed income options. These payments will have specific limitations and tax treatment depending on the contract. These guarantees are subject to the claims paying ability of the insurance company that issues your contract.
  • Non-qualified annuities are not subject to a Required Minimum Distribution.
  • If you choose to ANNUITIZE your contract you convert the value of the contract into a stream of guaranteed payments.
  1. You can no longer take distributions from principle.
  2. Each distribution is treated as earnings and premiums in proportion to the value at the time of annuitization. You will be taxed as regular income on the earnings.
  3. You can choose your annuitized payment plan.
  • Payments for the life of the owner. When that person dies. The distributions stop and the contract is closed.
  • Payments for a specified period. A specific number of payments are made. If the owner is deceased, the payments continue to a beneficiary until completed.
  • Life with period certain is a combination of the first two. Payments are made for the life of the owner, or for a guaranteed number of payments, whichever is longer.
  • Refund life. Payments are made for the life of the owner. If at the time of death the full premium amount has not been paid, a death benefit pays to beneficiaries.
  • Joint and survivor life. Payments continue for the life of the owner and their spouse. Payments stop at the death of the second spouse.

There are lots of options. Lots of jargon. And often there is a bit of sales hype when you are introduced to an annuity product. Take the time to be clear on what you need, and what you are buying.
If you are considering an annuity and would like some fiduciary advice on how it meets your needs, contact my office at I love to decode the complexity of annuities and help clients understand what they own and how it works. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.