A primer on what annuities are and why people use them.

As you consider your overall strategy for retirement planning, one product to consider is an annuity. There are many different types of annuities, so, before buying an annuity or annuities for retirement it’s important to look at annuity features and compare to see which annuity may be best for you. A fixed annuity is simply a contract between you and an insurance company that allows for the premium to accumulate potential interest that is not subject to market volatility prior to receiving income. Another type of annuity is a variable annuity which is invested in securities which are subject to market volatility then also provide a guaranteed income¹ based on multiple options. You can receive income payments on a scheduled regular basis (i.e., monthly, quarterly, annually) and those payments can be for a set number of years or guaranteed for your life span starting immediately or deferred for a potential inflation hedged future income.

A “Fixed Annuity” provides a guarantee on premium and income by the annuity issuer while a “variable annuity” provides more upside potential with a corresponding downside risk to principal and income based on the underlying investments of the annuity. In summary; with a fixed annuity, - the annuity company assumes all risk; with a variable annuity, the individual investor assumes all risk.

One great advantage of an annuity is that you are not limited to a set dollar amount of the pre-tax annual contributions you can make. This differentiates them from other tax-deferred instruments such as 401(k)s and IRAs. Consequently, you can sock away more money tax-deferred; and since the interest compounds, you have an edge over many other taxable financial vehicles. When you start drawing on the funds you can establish scheduled payouts (i.e. monthly), which is essential when planning how to budget for your retirement. An annuity can be a great benefit for your retirement; they are frequently used to supplement Social Security and other existing pension plans.

Reaching the point in your life where you are seriously contemplating retirement is a great feeling. You’ve saved money for many years and your financial advisor has recommended an annuity for your retirement. You might find yourself asking a few questions: Are annuities stable? Should you be putting all of your annuity money into one company, or is it better to diversify and split it up between several?

​While an annuity can be an advantageous instrument for your retirement planning, there are often some key issues to consider that should cause you to weigh your decision carefully to purchase such a product. This includes:

1. Commissions: Nothing good comes for free and annuities are no exception; they are offered through insurance agents and/or financial advisors with insurance license who are paid commissions by the insurance carrier.
2. Surrender charges: Pulling money out of your annuity ‘early’ will incur charges that typically run 7% to 10% of your accumulated value early in the contract. Surrender penalties typically decrease as annuities mature.
3. Tax: Annuities are taxed on interest at ordinary income rates instead of capital gains rates. Each individual situation varies based on various tax strategies, so, this may be seen as an advantage or a disadvantage.
4. IRS Penalties: Just like many other tax qualified retirement vehicles, annuities have an age requirement of 59 and 1/2 to avoid a 10 percent penalty tax on interest. Some immediate annuities, however, can circumvent these IRS tax penalties.
5. Annual fees: Investing in a variable annuity (one with ‘variable’ underlying investments) will incur annual expenses and account management fees that can total 3% to 5% a year, if not more. Over time, those expenses can take a big cut out of your retirement nest egg, limiting the growth of this type of annuity. Fixed annuities have low or no fees, premium protected, with modest to moderate growth.

As with any insurance product, investment or financial product, annuities have advantages, disadvantages, and certain non-market risks associated with them. If you consider an annuity as part of your retirement planning, it is essential to research them diligently and determine if they fit your current and future needs.