When someone asks me if I think annuities are good, my answer is, “it depends”. Annuities are neither bad nor good. It’s either are a good fit for the client’s needs or it’s not. An annuity at its core, is a contract between a client and an insurance company. In the case of some annuities those contracts are simple. A SPIA, or Single Premium Immediate Annuity is a guaranteed number payments of a specified amount in exchange for a lump sum initial payment. For example, if you purchased a SPIA for $100,000 dollars and assume the insurance company will pay you a 6% Single Life payout. You would receive $6000 per year for life.
Other annuities like variable deferred annuities (VDA) can have very complex rules and formulas to determine potential future income streams and death benefits. VDAs can have a few layers of fees, to include; the M&E fee or Mortality and Expense fee, any income rider fees or enhanced death benefit fees. As these are variable investments with potential for loss of principal due to down markets, they often offer a selection of stock and bond investment options to choose from. These internal investments themselves can have a separate cost called an expense ratio. You must understand how these fees both add value but also how they drag on the performance of the underlying cash. There must be a cost benefit analysis done to determine if the benefit of the annuity is worth the total of all fees.
Surrender charges are fees or penalties the carrier charges if you decide to liquidate (cash out) your annuity account before the surrender period is over. The surrender period typically ranges from 3 to 15 years specific to each contract. Many times, the surrender charge decreases with each passing year until eventually reaching 0% penalty thus freeing up your cash. For example, a 7-year surrender period with a surrender charge of 7% in year one, 6% in year two and so on, would have a 0% surrender charge after the 7th contract year. In addition to surrender charges, many annuities have other potential internal charges, rider fees and may have complex distribution rules. Before purchasing an annuity, it is critical that you must understand the pros and cons before making any decisions to purchase an annuity.
Visit our Annuity Planning page to learn more about annuities and download “the 8 things you must know before purchasing an annuity”.
Upcoming posts will cover Fixed Indexed Annuities and Variable Deferred Annuities in more detail.
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