Annuities Made Simple
Knowing if an annuity is right for you can be complicated, but doesn't have to be. At Element Wealth Management, we believe you should have all the facts to maximize your retirement benefits and minimize potential mistakes.
First, what is an annuity?
Annuities are long-term tax-deferred investment options that are managed by insurance companies or insurance "carriers" designed for retirement purposes. The main purpose is to provide steady income payments (typically after age 59 1/2 due to tax rule) to ensure you and your loved ones can maintain a similar standard of living and enjoy retirement. Similar to a pension or social security payment, annuities are designed to be most impactful in one's later years (60-65+) as gains are taxable as ordinary income upon withdrawal. Annuities differ from pensions and social security in that they are usually built on a schedule of a regular income payments that can stretch over varying amounts of time, but also allow you to maintain control over the asset. Annuities are not FDIC insured and contain surrender charges for withdrawals made prior to turning 59 and 1/2 subject to 10% IRS Penalty, if funds are not replaced. Guarantees are based on the claims paying ability of the issuing company.
Our most common types of annuities include, Fixed, Fixed-Indexed, and Variable annuities. There are other types, such as an immediate annuity, but we will focus on the main three.
Fixed Annuities: Most often, but not always have the lowest risk of the three. These products assure your money will earn at least a minimum interest rate that is paid on an annual basis over a specific timeframe (usually 5-7 years). However, focusing on the longer term options, you may be subject to interest rate risk. Some fixed annuities present an opportunity to potentially earn higher interest rates than prevailing CD rates at your local bank, and typically have a minimum interest rate granted by the insurance issuer. CD rates are FDIC insured to specific limits and offer a fixed rate of return if held to maturity.
Fixed-Indexed Annuities: a modified version of the fixed annuities, however they differ in that they earn an interest based on the change of a market index, such as the S&P 500 or the Dow Jones Industrial Average (DJIA). These indexes fluctuate daily. The interest rate has a floor of zero percent, so even if the market goes down, your principal is not at risk. It carries more risk than the fixed annuity as your rate of return is determined by the return of the underlying index over a specific amount of time that typically ranges from 1-5 years. Fixed Indexed Annuities (FIA) are not suitable for all investors. FIAs permit investors to participate in only a stated percentage of an increase in an index (participation rate) and may impose a maximum annual account value percentage increase. FIAs typically do not allow for participation in dividends accumulated on the securities represented by the index.
Variable Annuities: or "VAs" are the most complicated of the three and allow investors to generate a return on the performance of the investment portfolios through "subaccounts". VAs allow you (or your advisor) to dictate where you put your money. The return in a variable annuity isn't guaranteed as the value of the subaccounts you choose could go up or down, called market risk. If they go up, you could make money similar to a regular investment account. But, if the value of these subaccounts goes down, you could lose money.
Consequentially, income payments to you could be less than expected. To mitigate risk, "riders" are additional guarantee options offered through annuities and life insurance to help assure you have a minimum income return such as "5 for life", meaning you receive 5% of your initial investment for the rest of your life regardless of market performance or remaining account value. Some riders are included in an annuity while others are subject to additional fees, restrictions, and are based on the paying ability by the issuing insurance company. Variable annuities have significant fees and expenses known as M&E&A (Mortality and Risk Expense and Administrative Fees), subaccount fees and additional fees for riders. The policy holder should review their contract carefully before purchasing.
In conclusion, when it comes to annuities, it is essential to approach them with caution and seek the guidance of a valued and knowledgeable financial advisor. Making hasty decisions without fully understanding the product can lead to costly mistakes that may impact your retirement's fixed income. Researching and contacting a holistic financial advisor who can provide you with various options is important. Be wary of those who offer only one "flavor" of annuity, as it may not align with your specific needs and goals. While it may be tempting to save money by bypassing a broker, remember that the expertise and guidance of an expert can potentially save you from a costly mistake. Seek a professional's advice who's goal is to maximize your investment's return given your tolerance for risk.
Speak with one of our advisors today, cost free, and find out if an annuity is meant for you.