Annuities have been around for a while and have been the income source for a large number of retirees. First let’s understand what an annuity is. An annuity is a contract between you and an insurance company in which the company promises to make periodic payments to you, starting immediately or at some future time. According to the Financial Industry Regulatory Authority, Equity Indexed Annuities are complex financial instruments that have characteristics of both fixed and variable annuities. Their return varies more than a fixed annuity, but not as much as a variable annuity.
So EIAs give you more risk — but more potential return — than a fixed annuity but less risk — and less potential return — than a variable annuity. Like the world we live in, annuities were an easy-to-understand product but in recent years they have become very complex financial products. Today’s annuities have terms attached to them like Guaranteed Income Rider, Guaranteed Death Benefit Rider, Bonus Rider, Long Term Care Riders as well as now being able to participate in the S&P 500 Index for an added return.
I talk to a number of people daily and many are surprised their annuity has charges associated to it or they must hold their annuity for a fixed number of years or they risk paying a surrender charge to get out. Some annuities have 10, 12, and 15 year surrender periods that contain some very high surrender charges that would have to be paid before a person gets their money. This is a concern since people did not know that they would have to pay a surrender charges that could be 10 percent or 15 percent of their initial deposit. Annuities are not a bad tool as long as the person who is buying it understands what they have purchased and how long they have to hold the annuity. On one hand, I like having all the choices that an annuity can provide as well as the added benefits all in one product. However, a person needs to understand what each one of those terms means and most importantly how much do they cost. We already know insurance companies do not give away anything for free. On closer inspection, all fixed and index annuities have charges or expense fees associated with them. Since many of the fees are built into the annuities, they are not completely understood by annuity holders. An annuity can cost an person from .60 percent to 2 percent a year depending on what riders are attached and, yes, the expense fees do affect the growth of an annuity.
Annuities definitely have a place as part of your retirement planning but to say annuities fit all cases, I would express caution. If someone gave you a tool box and it only contained a hammer you would ask where are the other tools. Well that is what I am saying about annuities making up 100 percent of your retirement plan; they should be a part but not necessarily the whole. There is an exception to the rule, if you have sat down with a trusted financial advisor and based on those meetings the best solution would be met by an annuity, then see rule two. Rule two — get a second opinion before making a major decision on one annuity. Speaking to another financial advisor or your tax advisor usually helps answer additional questions about the annuity that may not have come up in your initial meeting. I view my retirement planning like I do my health. If my doctor is making a major decision about a medical procedure, I always get a second opinion. It’s not that I disagree or don’t trust my doctor, I just want to make sure the decision is the best thing for me.
Next, make sure you understand everything about the particular annuity. Annuities are not liquid products and depending on your age and the type of annuity you are considering they may have long holding periods before you can get your money back without some type of surrender charge. They do allow for some withdrawals of your principal, but the amount is usually 10 percent and even that can be after a waiting period.
Remember, fixed and index annuities can be great additions to your portfolio as long as you understand what you are buying. Look for annuities with low expense fees and short surrender periods. This allows you flexibility should you want to make a change in later years and more of your money is going to work for you instead of paying high expense fees. While some of the annuity riders offer some good benefits, the more riders you add to an annuity, the more the expense fees will rise.
