Comparing Top 2018 Annuities
Annuities are one of the oldest and most enduring retirement savings vehicles. An annuity is a long-term insurance contract between you and an insurance company. In exchange for a purchase payment or a series of purchase payments, your money will grow and eventually be converted into a stream of income.
Although the earliest annuities were very simple products, there are many different kinds available now. There’s an annuity available for just about every kind of investor.
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Annuities are worth considering for several reasons. Most compelling among those are annuities’ favorable tax treatment and their unique ability to create income that can’t be outlived.
How Do They Work?
The purpose of an annuity is to make an investment that will grow and, either immediately or at some point in the future, provide a stream of retirement income.
No taxes are due on annuity earnings until they are withdrawn. This allows gains to compound faster than they otherwise would. If withdrawals are taken after age 59 ½, gains are taxed at the ordinary income rate.
As we will examine later, there are different methods by which an annuity investment can grow. Once the annuity matures, you “annuitize” the contract, designing a stream of income that fits your needs. This income can be guaranteed for a certain period of years, for the rest of your life, or for the lives of you and your spouse.
Depending on the type of annuity you purchase, the annuity’s growth may be guaranteed, or you may bear some investment risk. Once the annuity is annuitized, however, the insurance company typically assumes all risk and guarantees the payments under the contract.
What Types are Available?
There are two main families of annuities: deferred and immediate.
In a deferred annuity, several years elapse between the purchase date and the date that income payments begin. This allows the owner a period of time to grow their investment, hopefully maximizing the amount of income they eventually receive. Immediate annuities have no deferral period, offering income that begins immediately after the annuity is purchased.
Whether deferred or immediate, each annuity can further be categorized as fixed, variable, or indexed.
In a fixed annuity, interest is credited at a stated rate that is guaranteed for a certain period of years. There is typically no risk of principal loss in a fixed annuity.
Variable annuities offer greater growth potential than fixed annuities, but they also involve more risk. Variable annuity purchase payments are allocated to “subaccounts,” which are funds within the annuity that function much like mutual funds. There is no limit to the growth potential of a variable annuity, but money can be lost as well.
A popular new type of annuity, known as an Indexed Annuity, combines the risk/reward features of fixed and variable annuities, creating a balance that has proven attractive to many annuity buyers. In an indexed annuity, gains are tied partially to the performance of a specified securities index, such as the S&P 500. The annuity participates in upside index performance, up to a stated ceiling known as the cap. In exchange for the limit in potential gain, the annuity also has a floor – usually zero percent — which keeps the annuity from losing money in “down” years.
Who Sells Annuities?
Most annuities are issued by life insurance companies. These companies have selling agreements with banks, broker/dealers, and insurance agencies, whose agents sell annuities to their clients. An agent who is selling an annuity must have an active insurance license in the state in which they do business.
Variable annuities and certain fixed and indexed annuities are considered securities because they involve the risk of loss of principal. These annuities must be sold by agents who have an active Series 6 or Series 7 securities license and are affiliated with a securities broker/dealer.
Annuities have a reputation for paying high commissions to the people who sell them, but this is not always the case. With increasing frequency, annuities are being sold by financial advisors who charge a flat fee for providing advice, and do not charge commissions on sales.
How to Effectively Compare Them
As with any investment, proper due diligence is needed to ensure you’re buying the annuity that’s right for you.
The first thing to consider is: when will you need income? If that’s going to be within a year or less, an immediate annuity may best suit your needs. If you have several years on your hands before you’ll need income, a deferred annuity might make the most sense.
The next thing to consider is your risk tolerance. If you are particularly risk-averse, especially if you are nearing retirement, a fixed or indexed annuity might be the best fit. When comparing fixed annuities, a high interest rate will be the main factor to consider. On indexed annuities, look for a high-performance cap.
If you can stomach some investment risk and have the time to recover from a potential short-term loss, a variable annuity, with its unlimited growth potential, might be for you. When shopping for a variable product, look for one with a broad menu of subaccounts. Variable annuities also typically come with mortality and expense (M&E) risk charges. The lower the M&E, the better for you.