This was the statement made by a recent referral I received. I was not surprised with all the negative press surrounding this product owned my millions of Americans. But, I was interested in how my prospect came to this conclusion. I asked him to tell me what an annuity was in his opinion. He said, 'An annuity is a product that pays you money every month, and when you die, the insurance company keeps the rest of your money.
For a minute I thought he was talking about Social Security; currently scheduled to go broke in 2037 according to the Social Security Administration. Now think for a minute. If this were true, do you think millions of Americans would have placed hundreds of billions of their hard earned money into such a product. Americans bought $34.9 Billion in fixed annuities alone the first quarter of 2009 (1)
The answer is no. Would almost every University, 501(c) 3, Church, and public school fund their retirement account with one? Would Congress be considering giving a tax break to Americans who purchase an annuity for retirement if it were true? No. So what is an annuity?
First you must be aware that the "term" annuity is often confused for the "product" annuity. The term annuity means "a series of payments guaranteed for a specific or lifetime term of years in order to methodically liquidate a specific sum and provide guaranteed income for the contractually guaranteed term." The "product" annuity is a contract sold by an insurance company that provides a future promise to pay income benefits a contract owner cannot outlive. Growth occurs on a tax deferred basis and income is taxed as last-in first-out known as LIFO when withdrawn. A 10% early withdrawal penalty may be applied to withdrawals made by a contract owner before the age of 59 1/2 unless owner uses provisions available under IRC Sec 72(t).
This is why annuities are used predominately for a retirement vehicle. It is important to note that there is no additional tax advantage to owning an annuity in your IRA or retirement account since they are already tax deferred. It is not however inappropriate to own an annuity in your retirement account if safety of principle is importnt to you. Many corporate pensions are partially funded with an annuity for that very reason. Fixed Annuities guarantee a fixed payment at liquidation while variable annuities do not. In a volatile interest rate or stock market environment, fixed payments make more sense to investors wanting to lock in a specific income stream that will not vary. Investors like annuities mainly for safety. There are several types of annuities and one must be sure of the specific form and uses of each.
Annuities come in 2 types - Immediate and Deferred.
Each type offers 2 forms - Variable and Fixed
Fixed annuities come in 2 types- Fixed Rate and Fixed Indexed- a hybrid product
The deferred annuity is an accumulation vehicle with certain guarantees attached including the right to move your money after the surrender charge period is over. This period can be any where from 3 years to over 15 years. I don't see any real value in getting a contract over 10 or 12 years though unless you just want your agent to make more commission for a small increase in your product promises or benefits.
Immediate annuities provide "immediate" income for a fixed period or lifetime depending on the income needs of the client. Investors should be cautious buying one of these and make sure they understand all the rules including provisions that may be unpopular with their heirs. Immediate annuities can provide the highest income for the amount of money used and can be very suitable for income planning as long as the client has adequate money in other accounts or life insurance in place for the heirs.
Deferred annuities come as Variable accounts and Fixed accounts. On Variable Annuities, the income payment in the future would vary with the underlying investment performance of the sub accounts. It is one way of owning mutual funds with the goal to outperform fixed rate annuities and create a future income stream that may be higher than one provided by a fixed annuity with consistent annual performance at a lower rate. By assuming the risk of investment performance, a client may get lucky and do well with this arrangement. On the other hand, the market could react like the last 10 years and you have no growth at all or even lose money. These products have several fees associated with them to provide certain guarantees. Investors who want protection from stock market risk may like the death benefit guarantees or income guarantees but these all come at a cost.
Fixed Rate annuities usually provide a fixed multi year interest rate or a first year rate with a floating rate in future years. They operate in a similar fashion to a CD in that interest is credited daily or annually or other term, but taxes are deferred until earnings are withdrawn. Annuities can be used to shelter interest income by retirees so they can avoid paying taxes on their social security income.
Fixed index annuities are hybrid products that credit interest based on the performance of an external stock market index. Interest credits can be no less than 0%, and many have an interest rate cap on the amount of interest that can be credited to the product in one year. The cap is one of the costs associated with principle protection. Some are uncapped but have additional design features that limit the upside as well. Index annuities have outperformed almost all alternatives that provide guarantees over the last 10 years and compared to the number of consumers that own them, complaints are surprisingly low. Some of these products appear to be quite complex. And clients should stay away from any products that have surrender charges for more than 10 or 12 years. Even though most annuities have liquidity of 10%-15% of the account value annually, caution should be taken if an advisor suggests you put all of it into only one account.
Annuities provide some compelling reasons to own along with some reasons not to own. Once you have compared all the products available on the market that provide safety and a good rate of return, you may find that you may be happy to own one of the safest places in America to keep some of your money too.
(1) Beacon Research, Fixed Annuity Premium Study, May 27, 2009 as quoted by Globe Newswire
Robert B. Scott - email him at rbscott21@gmail.com /800-228-3454 Not available in all states, No investment, legal or accounting advice is being given with regard to this article. Please seek the counsel of your trusted advisor in these areas. Licensed in TN, MS, AL, VA and IA.
http://www.nationalfinancialservicesgroup.com
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