What’s An Annuity? : Action Financial Strategies LLC | New Holstein, De Pere & Cottage Grove, WI

What’s An Annuity?

When it comes to various instruments you can put money into, at some point you may be exposed to the prospect of putting some money into an annuity. But what exactly is an annuity?

At a high level, an annuity is an investment contract typically issued from an insurance company that usually comes with certain benefits and guarantees. They usually come with the option to “annuitize,” which means to receive an income stream from the contract for a certain amount of time, typically for the annuitant’s life.

These income payments generally involve a return of principal, which you gave the issuing company for the benefits of the annuity. Often there is a death benefit guarantee that may or may not fluctuate with market conditions or other crediting means. The death benefit may depend on whether the client has annuitized the policy at the time the death benefit is made payable. A last note, on the standpoint of liquidity, control of the policy is surrendered at the point that annuitization of the policy begins.

Now when it comes to annuities, like ice cream there are many as many flavors and toppings as you could imagine. I’ll argue for the sake of this brief overview that there are three basic groups of annuities: Fixed Annuities, Variable Annuities, and Income Annuities.

  1. Fixed Annuities Fixed Annuities typically credit a certain amount of fixed interest for a period, anywhere from one year to ten years is typical. This crediting period is selected at the time of purchasing the contract. These contracts may also have a surrender charge, which is usually matched with the guaranteed interest crediting period. A surrender charge is a penalty for taking more that what might be allowed under the contract, typically taking out more than 10% in any year during that contract period.
  2. Variable Annuity Variable Annuities are market driven instruments that typically have an assortment of underlying funds or subaccounts to which you can allocate your investment dollars to gain market exposure and returns. These annuities carry more risk that fixed annuities because they are primarily market exposed. There are various riders or add-ons that can enhance the contract such as investment guarantees or death-benefit guarantees but each of these are different and vary by contract and company. These contracts also typically carry a surrender charge period, although not all do.
  3. Income Annuity Income annuities are guaranteed contracts with a set payout rate to start either immediately upon purchase, or after a few years when the income may be needed at a later date. These contracts act like a pension payment and usually do not allow the annuitant or owner of the annuity to withdraw more than what is already being paid to them. These also might carry features such as dividends from the company or other interest crediting possibilities to enhance the minimum guaranteed payout stated in the contract.

So which is right for you? There have been a few white papers out there by reputable accounting and finance firms, including some compelling analysis by Morningstar research which all point to using these alternative products to enhance retirement savings. Also they are being used to take withdrawal pressure off the retiree’s market portfolio by giving the retiree guaranteed income instead of relying on the market portfolio entirely for income.

In the end, working an annuity strategy into your plans could make a lot of sense, as well as give you additional options and possible stability in future distribution years. Just be sure to fully understand the product you are putting your hard earned money into. In the case of variable annuities and some fixed indexed annuities in particular, be sure to always read and review the prospectus and other sales materials, and match the benefits or features you selected with what was noted on the application. Also be sure to understand all the costs associated with your annuity so you can weigh if the features you are paying for are meaningful to you.

Some of these products can be very complex, and I’ve run into many cases where what the client thought they had purchased wasn’t what they owned. Also, know that most annuity contracts have between a 10- and 30-day free look period, where if you decide to not want the contract in that time, the insurance company has to return and reverse the funds back to your original accounts.

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Bradley Ruh Owner, Financial Adviser

This material is for general informational purposes only and was produced by Action Financial Strategies, LLC.

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