When you hear the word “annuity,” it might conjure up visions of retirees receiving income and enjoying their time relaxing on the golf course or a beach. On the other hand, you may have a vision of investors who must pay a fee to “unlock” their money if they withdraw it from the annuity “too soon.” In any case, it is essential that you compare annuities before you commit to purchasing one.
That’s because not all annuities are exactly the same. Some annuities may be better than others, depending on what your specific short and long-term financial objectives are. An annuity can also be “expensive” to get out of if you discover that you bought the wrong one. So, here’s what to look for.
How Annuities Work
While there are many different variations of annuities, there are really just two main categories. These are fixed annuities and variable annuities. As far as the structure of these products goes, there are a number of similarities. This is even more reason to compare annuities before you commit to one.
For instance, if you own a deferred fixed or variable annuity, you will be able to grow the funds in the account on a tax-deferred basis. This means that there is no tax due on the gain until the time of withdrawal.
In the future, you could convert the annuity into an income stream that lasts for a set period of time – like 10 or 20 years. Or you could opt to receive annuity income for the remainder of your lifetime.
There could be other similarities, too, between the fixed and the variable annuity. Some examples are the inclusion of a death benefit and/or features that offer you penalty-free access to the money in the account in certain situations (such as if you are diagnosed with a chronic or terminal illness).
Where you find the primary differences between fixed and variable annuities is in how the return is calculated. Because of that, the right annuity for you will depend in large part on your risk tolerance, as well as on how you plan to use the annuity.
Fixed annuities offer a set interest rate that may be locked in for a specified period of time, such as 3 years, 5 years, 7 years, or even 10 years. After that, the interest rate may be reset by the insurance company. But it will not fall below a guaranteed minimum, so you can count on at least some amount of return each year.
Should you decide to convert the annuity to an income stream, you will be able to count on a set payment amount for the income period you select. This could be for a pre-selected period of time, or for the remainder of your life – no matter how long you live.
Fixed Indexed Annuities
Fixed indexed annuities use different methods for calculating return. These annuities track one or more underlying market indexes, such as the S&P 500 or the DJIA. In contract periods where the index performs well, the annuity is credited with a positive return – up to a limit, or “cap”.
But, if the index(es) does not perform well and it incurs a negative return for that period, the annuity will not lose value. Rather, it will just simply be credited with a guaranteed minimum “floor” rate.
This protection of principal means that when the tracked index comes back up, there are no losses to make up for – and the compound, tax-advantaged growth may continue. Like a regular fixed annuity, a fixed indexed annuity will also typically offer several different income payout options to choose from.
Due to their similarities, it is recommended that you compare annuities. This is true, even if they are in the same category (such as fixed or fixed indexed). That way, you’ll have a better idea of what features they do or do not possess).
Variable annuities generate their return based in large part on investments such as mutual funds. Unlike fixed indexed annuities, though, a variable annuity won’t usually impose a limit on the amount of your upside earnings. However, there is the potential for downside risk. So, it is possible that you could lose principal if the underlying investments perform poorly.
Also, the amount of income that is generated using a variable annuity can fluctuate in amount. Therefore, if you are counting on a specific dollar figure each month or year, you may not be able to accomplish that with a variable annuity.
Fixed, Indexed, and Variable Annuity Comparison
|Fixed Annuity||Fixed Indexed|
|Rate of Return/Growth Opportunity||Set rate of fixed interest||Return based on performance of underlying index; upward potential usually limited||Potential for market-linked growth, often with no limitations|
|Risk Factors||Low return; usually locked in for a set period of time||Funds locked in for a set period of time (or risk of a surrender penalty)||Risk of market-related loss|
|Early Withdrawal Penalty||Yes||Yes||Yes|
|Who May Benefit||Risk averse investors||Those looking for higher return potential, and protection of principal||Investors seeking higher returns who have more tolerance for risk; investors seeking tax-deferral (even if retirement plan contributions are maxed out)|
Which Type of Annuity is Best for you?
There really isn’t one “best” annuity for everyone across the board. Rather, which annuity is right for you – if any – is the one that most closely fits in with your particular goals and needs. So, even if this type of financial vehicle is a good fit, you should still compare annuities before you move forward.
If you would like more information about comparing annuities – including one that you already own – give Annuity Gator a call at (888) 440-2468 or send us an email to our secure online contact form, and we will be happy to assist you.