What You Should Know About Annuities

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Say it with me… annuity.  Now hear me out before you click out of this blog. It’s amazing how the word annuity can stir up such a debate.

Maybe your toes curled up, and your shoulders tensed.  Knowing you need to defend against the evil empire that is annuities.  Or maybe you believe them to be the best thing since sliced bread.

Well, guess what?  SPOILER AHEAD— Annuities are not out to destroy the world, and they weren’t created to help make world peace.

Regardless of your opinion (or mine for that matter), annuities are here to stay.  And because of that, it’s important to understand how they work, what the benefits are, and if they belong in your financial plan.

So what is an annuity?

An annuity as defined by Investopedia, is the following:

A financial product sold by financial institutions that is designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual at a later point in time.  Annuities are primarily used as a means of securing a steady cash flow for an individual during their retirement years.

Side note – don’t you just love definitions that use the word or a form of the word in them?

What does that definition mean?

It means this.  You take a portion of your money and give it to an insurance company.  The insurance company, in exchange, promises you an annual payment.  The amount of that annual payment is going to depend on a combination of things:

  1. When do you want your first payment?  Do you want it now, or do you want it later?
  2. How long do you want that payment to last?
  3. How old are you?
  4. Are you male, or female?
  5. What type of annuity is it?

When are most annuities purchased?

Most annuities are purchased by those nearing, at, or in retirement.  For those who have little to no retirement income (pensions are rapidly becoming a thing of the past), an annuity can replicate a lot of what the pension was doing.  It can provide lifetime income.  But before you jump in, here are a few big questions to ask yourself.

  • How much income do I have in retirement?  And how much do I need?
  • Am I O.K. locking this money up for a long period?
  • Am I O.K. with having limited access to the money?
  • What is my investment risk tolerance?
  • Do I have adequate other resources in case of an emergency?
  • How does this fit into my overall retirement plan?
  • Are the benefits worth the cost?
  • What is the cost?

Purchasing an annuity (if you decide to) is a big decision, so take your time, and make sure you do your homework.

What you need to know before purchasing an annuity.

  1. Annuities are complicated – Make sure you read all the fine print and understand the good and the bad.  It’s easy to get caught up in the bells and whistles, but there are two sides to every story.  Make sure you know both.
  2. Annuities often lock your money up – Annuities often have surrender charges that last anywhere from a few years (3-4) to many years (sometimes ten years or more).  If you want out, you may be hit with a severe penalty.
  3. Annuities can be expensive (even ones that are “free”) – Variable annuities have fees that are spelled out.  Other annuities (immediate, fixed,  and indexed) do not have specific “fees”, but I can assure you they are embedded in the product.  You’re paying for it somewhere along the way.
  4. There are different kinds of annuities – some better than others – Not all annuities are created equal, and not all serve the same purpose.

What are the different annuities?

  1. An immediate annuity (aka – the SPIA) – With a SPIA, you trade a lump sum of money for a series of annual payments, often payments for a lifetime.
  2. A fixed annuity – This works much like a CD at the bank.  The insurance company offers you a fixed rate of interest for a certain number of years.
  3. An indexed annuity – In my opinion,  indexed annuities are the worst of the group.  If someone is selling you one of these, run!
  4. A variable annuity – Upside… and downside market participation, with the option for guaranteed lifetime income.  In my opinion, this is often the most attractive of all the annuity options.

What do I think of annuities?

Annuities are generally oversold and over promised. They can be positioned in an extremely attractive manner by relentless salespeople looking to make a quick commission.  My advice to you if you are being presented an annuity, proceed cautiously.

I do believe there can be a place in some financial plans for an annuity.  But not all the time, and it is not necessary.

What now?

Keep in mind the term annuity can mean a lot of things.  It’s premature to determine whether its a good idea or bad idea based simply on hearing the term.  So make sure you know exactly what type of annuity is being referenced, how it works, and how it fits into your plan.

At the end of the day, it’s up to you to determine what is right for your portfolio.



In reference to general account obligations and guarantees, such as is present with fixed annuities, the ability for the insurance company to meet these obligations to policyholders are subject to sufficient capital, liquidity, cash flow and other resources of the insurance company.

Indexed Annuities are not securities. Interest payments are contractual obligations of the insurance company.  Refer to policy for specifics regarding when interest is credited (usually only for funds held for of a specified term) and how interest is calculated (may be less than actual index due to expenses and exclusion of dividend earnings of the index).  Past performance of the index is no guarantee of future changes in the index or of future indexed interest earnings.

A variable annuity is an insurance contract which offers three basic features not commonly found in mutual funds: (1) annuity payout options that can provide guaranteed income for life; (2) a death benefit; and (3) tax-deferred treatment of earnings.  When applicable, the tax deferred accrual feature is already provided by the tax-qualified retirement plan (e.g. 403(b), IRA, etc.).  The U.S. Securities and Exchange Commission (Investor Tips:  Variable Annuities) has suggested that it may be more advantageous to make the maximum allowable contribution to a tax-qualified retirement plan before investing in a variable annuity.  The separate account of a variable annuity is not a mutual fund.  While separate accounts may have a name similar to a mutual fund, it is not the same pool of funds and will experience different performance than the mutual fund of the same or similar name.  In addition, the financial ratings of the issuing insurance company do not apply to any non-guaranteed separate accounts.  The value of the separate accounts that are not guaranteed will fluctuate in response to market changes and other factors.  Variable annuities are designed to be long-term investments and early withdrawal may subject me to tax penalties and charges.

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