Recently, I’ve been talking to my financial adviser about my annuity and we were discussing how the annuity he set me up with several years back has really saved my butt considering the current economic conditions we’re living in.

So in this article I’m going to spend time getting you familiar with them and give you the good and the bad reasons why you should consider buying annuities.

What Is An Annuity

So the first thing we need to do define what an annuity is.  An annuity is a type of insurance; in fact it does the exact opposite of a life insurance policy.  A life insurance policy protects you from the financial risk of dying to soon, were an annuity policy protects you from the financial risk of living to long.

The truth is people are living longer and longer these days.  When you add the fact that people are saving less and less an annuity starts to make sense.  Why, because an annuity could become a source of income that will pay you for the rest of your life.  To understand how these investments work we need to dig a little bit deeper.

How Annuities Work

Annuities work in much the same way mutual funds do.  With a mutual fund your account is allocated into many different funds.  The same is true with an annuity, however they are not called funds they’re called sub-accounts.  The money is invested the same way as a mutual fund as well but there are some small differences.

• Annuities can be fixed or variable. So annuities have a fixed rate of return while others are variable which means it is invested in the stock market.
• You can annuitize. Annuitization is the process of changing ownership of the annuity from the owner of the annuity to the insurance company itself.  The insurance company will then pay you every month for the rest of your life, no matter what.  If you should happen to exceed the amount of money you have in the account they will keep on paying till you pass on.  Not a bad deal.
• You can add a rider to the policy. Much like a rider to a life insurance policy, annuities have riders to do all sorts of things for your policy.  More on this later in the article.

Should You Buy Variable Or Fixed

One of the first things and annuity buyer should consider when you buy an annuity is whether you want a variable or fixed policy.

Fixed

• First off, a fixed policy does just what it says, it holds a fixed interest rate and doesn’t lose value.  The typical rate is around 5% on most annuities but that isn’t to say it will always stay that way.  They tend to change over time.

• Next, fixed policies tend to have longer surrender periods, usually 10 to 15 years.  A surrender period means that if you would happen to surrender your policy at any time before it’s up you will lose some portion of you total amount.  The surrender period will also decrease as time goes on.  For example, if you would surrender your policy in year one you might take a 10% lose on your account.  However, in year two it might only be 9% and in year ten it might only be 1%.

• Finally, the upfront charges are usually around 7% to 8%.  This is a very high fee to pay but not all annuities are like this.  You just have to shop around and consider all of your options.

Variable

• First, variable means to invest in the market.  It can lose value just like any other investment and is not guaranteed to earn any certain return.  However with greater risk comes the possibility of earning more.

• Second, variable policies have shorter surrender periods.  They can be as short as 4 years and as long as 10 years usually.   My annuity had a four year surrender penalty and has already surpassed it.  That means if I would close my account out tomorrow I could get all of my money back minus taxes of course.

• Finally, the upfront fee’s with a variable annuity are usually a lot less.  They usually range from 4% to 6% depending on the amount of money you are putting in up front.  For example the annuity I own only takes a 4% charge up front but once it crosses the $10,000 threshold it will go up to 6%.

However there is one thing I forgot to mention, when the surrender charge decreases the upfront fees will decrease as well.  For example, if you started out with a four year surrender penalty at 8%  and in year five it was 0% you would also pay no upfront fee as this would have decreased as well.

Now this isn’t saying all annuities are like this but you will defiantly want to cover the points I mentioned above with your financial professional before making any big decisions.

What I Like About Annuities

While annuities can seem a bit complex at first there are a few things I like about them a lot.

• No front end and back end fees if you keep it. Like I mentioned above if I hang on to the policy long enough I’m not paying any fee’s.

• Policy Riders. Think of riders as an add on to your policy and what I like about them so much is that they can do so much with so little.   In fact one of the riders on my policy has a lock in period which allows me to lock in my account value once a year and in seven years from that lock in point if my policy hasn’t increased beyond what I locked it in at they will automatically bump me back up to that value I locked in at.

• You can annuitize at any time. Like I explained above annuities can be annuitized and pay you for the rest of your life but what is even better is the fact that you can do this whenever you want to.  You don’t have to be a certain age to annuitize a policy but it’s just the fact that I can when I want to.   Just remember though with less money in your account you will receive less of a payout.

What I Don’t Like

With all the things that are so great about annuities there are always some things that I don’t always agree with, so to give a fair and honest review here are some things I don’t like.

• Fees are higher in the beginning. Fees are always higher with annuities as with mutual funds few are usually less than 6%.

• They have higher investment requirements. Some policies will only require as little as $1000 up front while others will require anywhere from $15,000 to $20,000 or more just to open the policy.

• Annuitizing gives you no control. I like the fact that I can annuitize and get a paycheck for life but what I don’t like is that once it’s done it’s done.  There is no reversing it, once you’ve given your money to the insurance company it’s only coming back to you in the form of a  monthly paycheck.  However, that doesn’t mean you have to annuitize, no one ever said you had to, and don’t let the insurance company tell you otherwise.

Who Should Buy Annuities

Not everyone should have an annuity, below I will list who is better qualified to have an annuity than others.  I also want to mention you should consider all options with your financial professional and take time to make this decision.

• If you’re older than 55 don’t buy an annuity. At 55 a variable policy will be too risky investing your money in the market, while a fixed policy will usually have to long of a surrender on it before you can start withdrawing money from the policy.  However, if you are older than 55 and still are considering an annuity you can put it into an immediate annuity which usually has no surrender or upfront fee’s, although it will be annuitized immediately and you will no longer have control over it.

• If you want added benefits like the lock in period I mentioned earlier they may be right for you.  There is a bunch or riders you can add on to your policy to help spruce it up a bit but just remember they do have a cost behind them as well.

• If you like getting a guaranteed check every month this may be for you.  I should also mention that if you have a fixed annuity your payment will always stay the same but a variable policy will change because it is invested in the market.

Call To Action

Now it’s time to take that leap, and you may not be ready yet.  If not reread this article and consult your financial professional.  Also don’t let anyone rush you when you buy an annuity.  Making a bad decision now could cost you, but by putting in a little time now to research and compare you will save yourself a lot of headaches and have much better retirement as a result.

Chris

This article was recently featured on the Money Hacks Carnival by Being Frugal.