What is an annuity?
An annuity is a guaranteed contract between you and a life insurance company. You make a deposit called a premium payment and in return you receive a guaranteed financial contract that has stated terms and conditions. Annuities can be used to grow your money or to provide a guaranteed lifetime income stream. It’s possible to use some annuities for both growth and lifetime income. Annuities have been in use for centuries; one of the earliest recorded uses of an annuity in the United States was by the Presbyterian Church in 1720.
Are there different types?
There are two primary types of annuities sold in today’s marketplace:
- Variable Annuities - Variable annuities place your money directly in the stock market and will go up and down with the stock and bond market, depending on the investments made. Some variable annuities have fees of 2-3% per year because of the cost of the mutual funds and the insurance expenses.
- Fixed Indexed Annuities (FIA) - This type of annuity does not place your money in the stock market. Though annual return is benchmarked to an index (For example, the S&P 500), your money is never directly exposed to the stock market. FIAs may have features such as principal protection or safety against loss in market down years, as well as the opportunity for growth. Some FIAs do not have annual fees.
Is an annuity right for me?
We believe this can only be determined by working with a retirement specialist who understands your retirement vision, risk tolerance, needs and goals. Annuities are not right for all investors or retirees. For some retirees, fixed indexed annuities may be a powerful asset class with the potential to reduce portfolio volatility, and grow a portion of your assets without the risk of market loss. Depending on the contract, an annuity may also have options that provide a guaranteed income stream you can never outlive.
Are annuities safe?
It depends on the type of annuity you purchase. Fixed Indexed Annuities are safe from market losses and provide 100% guaranteed protection of your principal. Variable annuities on the other hand can lose value if the market goes down. The safety of any annuity contract depends on the financial strength and claims-paying ability of the issuing insurance company.
Are life insurance companies safe?
Highly rated life insurance companies can be among the strongest financial institutions in the world. They operate under a dollar-for-dollar legal reserve system which ensures they have financial reserves backing more than 100% of their liabilities. Additionally, they are audited independently by every state in which they operate, providing oversight of their financial stability. Additionally, life insurance companies must invest the majority of their assets in US Government Bonds, Investment Grade Corporate Debt, and Real Estate. Only a small portion of their assets may be invested in the stock market.
What about AIG? Didn’t we bail them out?
AIG has two primary lines of business: a banking business and an insurance business. The bailout of 2008 was for their banking unit. AIG the life insurance company was A+ rated throughout the 2008 crisis and no policyholder was ever in jeopardy of losing a single penny due to the strict laws of the insurance industry. While AIG’s investment bank did require government intervention, the insurance side of AIG’s business had over $1 Trillion dollars in reserve for their policyholders. The firewall between the insurance business and banking business ensured that AIG could not borrow from their insurance business to fund their failing banking business.
Are annuities better than bonds?
It depends on your specific and personal situation. We believe that everything depends on your retirement vision, risk tolerance, needs and goals. We also believe that in a rising interest rate environment, FIA’s may provide better downside protection and more upside potential than bonds. It may be prudent to consider FIAs and bonds in conjunction to reduce risk in a diversified portfolio.
What is the purpose of an annuity?
Annuities today are used for multiple purposes. One of the uses of Fixed Indexed Annuities is to provide opportunity for growth while protecting against downside risk. Some annuities may also have an option to provide guaranteed lifetime income.
Do annuities have high fees?
The majority of Fixed Indexed Annuities have no annual fees for the base contract. Some policies will offer riders that can be added for an additional cost, which depends on the contract, but is often around 1% per year. Variable annuities have fees that can be 2-3% per year, and also have riders that can increase that cost by up to 5% per year, depending on the contract.
Why would I consider a fixed indexed annuity?
We believe FIAs may be appropriate for investors who desire a portion of their money to be protected against downside market risk in retirement, but also want to retain the potential to earn a higher interest rate than available in cash or CD’s. Additionally, we believe retirees who favor the idea of having an income stream paid out monthly or annually for their lifetime may consider FIAs as a potential option. Finally, our view is that investors who seek to reduce the total risk of their entire portfolio may consider utilizing an FIA in conjunction with, or as an alternative to, bonds.
What is a cap? What is a participation rate?
Since Fixed Indexed Annuities provide protection against downside market risk, they also limit the upside potential available to policy owners. If this were not the case, policies would be providing 100% safety and 100% of the upside of the market. That isn’t reasonable. Many FIAs limit the upside through the use of either a participation rate, or a cap on earnings.
A cap is simply a limit on the amount a policy owner can earn in a given year. For example, a cap of 6% means the potential maximum annual return would be 6%. Suppose an annuity is indexed to the S&P 500. Your cap is 6%. If the S&P returns 5%, you make 5%. If the S&P returns 6%, you make 6%. If the S&P returns -5%, you make 0%. And if the S&P returns 20%, you will make 6% because that 6% is your cap.
A participation rate, or “index rate,” is another way that many annuity policies limit upside potential. A participation rate is simply the percentage of an index that is used to calculate the return that a policy provides. For example, if your annuity is indexed to the S&P 500, the participation rate is 50% and there is no cap, then you would earn half of the S&P 500’s annual return, without risk to your principal. If the S&P returns 10% you earn 5%. If the S&P 500 returns 30%, you would earn 15%. If the S&P 500 returns -5%, you make 0%.
Do annuities have low returns?
The potential returns of an annuity depends on the terms and conditions of each particular contract. The terms of some annuities may result in lower potential returns, and the terms of other annuities may allow higher potential returns. We believe that for many investors, uncapped FIAs provide the best opportunity for potential return, though the appropriate contract will depend on your specific circumstances, objectives and risk tolerance.
What is a lifetime income rider?
A lifetime income rider is an addendum to your contract, available for an additional cost, that you may elect to add. This feature comes in many different variations, but ultimately allows you the choice of a guaranteed lifetime income without sacrificing access to your principal for emergencies. Some lifetime income riders may also allow your principal the potential to continue earning interest while you receive your guaranteed lifetime income. This can aid in increasing the potential death benefit for your heirs. It’s important to remember that, just like annuity contracts, riders contain terms and conditions that have to be understood before purchasing.
What is annuitization?
Retirees have choices when it come to electing a lifetime income stream. One of those choices is annuitization, which is different from electing a lifetime income stream through a rider. Electing through a rider, with or without a fee depending on the contract, retains access to your principal for emergencies and provides a potential death benefit.
Annuitization is the option of converting an annuity into a series of periodic income payments. The option to annuitize a contract is included on all annuities and is the oldest method of electing a guaranteed lifetime income. We believe that a downside of electing this option is that you may forfeit access to your principal and death benefit in exchange for a guaranteed lifetime income. At the time of election, you may be able to choose a specified number of years your income payments will continue should you pass away unexpectedly. A potential benefit to annuitization is something known as the “exclusion ratio.” This is an IRS law that can provide tax-advantaged income if used in conjunction with non-IRA money, inside an annuity.
If I die, will the insurance company keep my money?
Generally, no. This is a common perception that came about because sometimes an annuity owner would choose to annuitize their annuity and elect the option that pays them the most income annually while they are alive, but leaves no death benefit if they die early. If you don't voluntarily elect this option, the remaining death benefit on your policy will be paid out.
What are the commissions paid on annuities?
Annuity commissions are paid out of the marketing budget of the insurance company’s budget. They do not come from your account and do not reduce the value of your deposit. The typical commission an insurance agent receives for selling a fixed indexed annuity is between 4-7%.
Can a life insurance company go bankrupt?
No. A life insurance company cannot declare bankruptcy. If they fall below the dollar-for-dollar legal reserve requirement, they go under supervision and if the delinquency is not resolved in a timely manner, they may go into receivership with the state. The state will transfer your policy to another carrier and all guaranteed elements of your policy remain intact.
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