Annuities Questions and Answers: Learning the BasicsSubmitted by Reby Advisors | Certified Financial Planners | Danbury, CT on October 26th, 2018
Q&A with Rudolf Weiss, CFP®, October 26, 2018
Considering investing in an annuity, or just wondering what they are and what they do? Learn more about annuities with CERTIFIED FINANCIAL PLANNER™ Rudolf Weiss of Reby Advisors. While we only recommend annuities for people who can genuinely benefit from them, we think it’s important for everyone to have an idea of what annuities are, their risks and benefits, and how to choose the right one.
What is a fixed annuity?
A fixed annuity is basically a certificate of deposit with an insurance company, usually guaranteed through the state guarantee fund. In a typical plan, you will invest your money for five years and get approximately 3% per year tax deferred until you start taking the income out.
What is an immediate annuity?
In an immediate annuity, you give your money to the insurance company and they will pay you a guaranteed income for life. In this type of annuity, you’ll never have access to the original principal again.
What is a variable annuity?
A variable annuity is the most popular type of annuity right now. You invest your money into different investment portfolios and add a guarantee of income or guaranteed death benefit on top of that. Some people can’t retire on the 3% per year that they might receive on a fixed annuity, but they’re uncomfortable with investing in the stock market. A variable annuity with lifetime income guarantees can allow them to have a successful retirement.
What happens to a variable annuity after I die?
In the case of variable annuities, most plans have a “return of premium” death benefit. That means your beneficiaries will get back, at the very least,
- What you put into the annuity minus what you took out
- Or the current value, whichever is greater.
In some cases, people pay for an enhanced death benefit. You can pay a percentage of your gain in addition to the current value to help defray some of the tax cost. Sometimes, you can get a benefit that increases by a certain percentage each year, usually 5%, until your death.
What’s the difference between mutual fund investing and variable annuities?
Variable annuities contain variable investments that are very similar to mutual funds. When you look at it that way, it seems like there’s little to no difference between getting a variable annuity and simply investing in mutual fund. But there are a few differences:
- Even annuity money not in a qualified IRA or pension plan will grow tax deferred until you start to take it out.
- Annuities have the potential to earn more than you would in a fixed vehicle.
- Annuities offer death benefits, which are not available in a mutual fund.
- Annuities also offer guaranteed income in retirement.
- Mutual Funds will normally have lower fees because they do not provide death benefits, tax deferral or guaranteed income.
- Income from annuities is always ordinary income, income from mutual funds can be interest, dividends or capital gains. Dividends and capital gains may be eligible for preferred tax treatment.
Do variable annuities always come with a death benefit?
Yes, all variable annuities offer some type of death benefit. In some of the most affordable “budget” plans, the death benefit is simply the current value. However, you usually get more out of your death benefit than that. In the majority of variable annuity plans, the beneficiaries will get either the current value, or what you put in minus what you take out—whichever is greater.
What is an enhanced death benefit?
If you are willing to pay more, you can get an enhanced death benefit. This will either pay out a higher percentage of the gain or increase the death benefit by a certain percentage each year. So, for example, one common one is 5% per year. If you put in $100,000, the death benefit goes up 5% per year irrespective of how the market performs.
How do I pay for an annuity?
There are a few options. You can pay a large lump sum upfront, or you can add money to it over time. Most plans have a minimum requirement, but that might be as low as $2,500.
How does the cash flow benefit work? How often will I get money from my annuity?
Once you “turn on” the income from your annuity, you can choose whether you want it monthly, quarterly, semi-annually, or annually. Most people get an automatic EFT (electronic funds transfer) into their checking accounts.
Are there penalties for taking out too much money?
Yes. Most variable annuities have a penalty. Generally, the penalty occurs if you cash out the entire annuity in the first seven years. You can also have restrictions if you have a lifetime income guarantee. In addition, you might lose your death benefit if you take too much money out, generally if the cash value goes down to zero. However, the penalties and restrictions are different for every company. Make sure you’re aware of the rules for your specific plan.
What types of guarantees can I buy with my annuity?
You can get guaranteed income. There are several different types of guaranteed income. Some programs have a “doubling feature.” If you haven’t taken money out after a certain period of time, they’ll base your income on double what you put in! And, some companies let you pay a little bit extra to reduce the surrender charge.
Is guaranteed income exclusively for retirees?
No, some companies will let you take it from Day 1. However, you might have issues if you are under 59½ years of age. In some cases, you need to wait 10 years before you can take it. It all depends on the company and the program.
How much guaranteed income does an annuity typically offer?
Normally, if you have it for more than five years and you're over 65, 5% is pretty common.
Do annuities provide for spouses?
Not necessarily. You will need to make sure that whatever benefit you’re purchasing also provides for your spouse, because not all of them do.
Who should be investing in an annuity?
Every client is different. It depends on your income needs. Theoretically, you could potentially earn more income from a managed advisory account, using exchange traded funds and mutual funds, than from a variable annuity. But there's no guarantee. People who are worried about stock market volatility may be better candidates for a variable annuity so they can sleep a little better at night. Ask yourself these questions: What kind of income do you need to survive and have a successful retirement? What is your investment makeup? How much volatility can you handle and sleep well at night? This can help you decide if an annuity is right for you.
What are some of the risks involved in annuities?
One major risk is that most companies have the ability to raise their expenses over time, which would hurt performance. And, if you end up needing more money than you are supposed to take out of the annuity, this can also hurt your finances in the long run. Another risk is that sometimes, people choose the wrong type of annuity if they don’t have the right guidance from a good advisor.
What are some warning signs of a “bad” annuity?
If someone is pushing an annuity on you and trying to sell it rather than advising you and offering options, that is a red flag. If you don’t understand a product that someone is trying to sell you, turn around and go to someone who will take the time to help you understand your best options.
If you have questions about annuities, leveraging your assets to generate sustainable retirement income, or how much of your income total income needs should be from guaranteed income, request a 15-minute discovery call with a financial planner at Reby Advisors by calling (203) 790-4949 or click here to send us an email.