Frequently Asked Annuity Questions and Questions to Ask Advisors

The information on this page has been compiled after Years of fielding annuity questions and it is intended to be informational only.  Each situation is unique and each carrier will have their own set of contract terms and features.  This information is general in nature, designed strictly for informational purposes and does not constitute an offer nor is it it to be considered tax or investment advice.  It is my hope that you find this information to be helpful and that it provides you with some good questions to ask an agent/advisor when an annuity is recommended.  Annuities have the ability to provide extraordinary benefits when the situation is suitable but unfortunately, they have become a widely misunderstood financial instrument.

WHAT IS AN ANNUITY?

A contract between an insurance company and the policy owner/annuitant where the owner provides either a lump sum premium or a series of premiums in exchange for an income at some point in the future.  There are many ways to structure the payment and some of the common settlement options are; life only (this is the one where payments stop when the annuitant dies), life with cash or installment refund, life with period certain, fixed period or fixed amount.  With a deferred annuity, you can either select a "fixed" growth or a "variable" one.


WHO ISSUES ANNUITIES?

Annuities are issued by insurance companies and sold by licensed insurance agents, financial advisors and independent brokers. These agents and brokers have met additional annuity education requirements in accordance with the laws of their State and are required to update such training and satisfy continuing education requirements.

 

WHAT'S THE PURPOSE OF AN ANNUITY AND IS IT AN INVESTMENT, SAVINGS VEHICLE OR AN INSURANCE PRODUCT?

Depending on the type of annuity purchased, it could be a combination of all three but by nature, annuities were designed as a risk transfer vehicle to protect retirement income. While there are multiple annuity varieties and riders available, annuities can generally be broken down into fixed & variable and will be either immediate or deferred.  Fixed and fixed indexed annuities are savings vehicles that are a part of the insurance company's General Account and are not subject to stock market risk.  Variable annuities (including RILAs or Registered Indexed Linked Annuities) are indeed investments as they are not protected from market loss, although certain protective riders may be available for an additional charge.  

Whereas life insurance provides for protection in the event of an insured's death, annuities transfer the risk of an annuitant living too long to an insurance company.  The history of lifetime income guarantees dates back to the days of the Roman Empire.

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WHAT IS THE DIFFERENCE BETWEEN FIXED AND VARIABLE ANNUITIES?

A fixed annuity is a type of insurance contract that promises to pay the buyer a specific, guaranteed interest rate on their contributions to the account.  Some common fixed annuity types are; single premium deferred, flexible premium deferred, multi-year guaranteed, fixed indexed, single premium immediate and deferred income annuities. 

By contrast, a variable annuity is invested in equities and pays interest that can fluctuate based on the performance of an investment portfolio chosen by the account's owner.  


WHAT IS THE DIFFERENCE BETWEEN DEFERRED AND IMMEDIATE ANNUITIES?

A deferred annuity is useful if you’re looking ahead to have a regular income at some later point in time, whether that’s in a couple of years or a decade.  It is referred to as a "deferred" annuity because the owner is deferring income until a future date, however most deferred annuities will allow an annual "free amount" that is not subject to withdrawal charges.  One advantage of this type of annuity is that your premiums grow tax-free during the period leading up to when you start receiving them.

With an immediate annuity, the owner/annuitant purchases the policy with a lump sum payment and he/she begins to receive payments immediately (or generally within the first Year). An annuitant often buys an immediate annuity after he/she has reached retirement age and wishes to receive his/her savings or other money in an organized manner.


GENERALY SPEAKING, WHO BUYS ANNUITIES?

Among other considerations, it depends on your age, liquidity needs, projected retirement date, the status of your retirement savings and whether you are still contributing to a qualified plan such a 401(k). There are many factors to consider when determining annuity suitability.  Whether you purchase an annuity within a qualified account (IRA for example) or non-qualified account (funded with "after tax" dollars), in most cases the IRS imposes early withdrawal penalties for any funds withdrawn before the attained age of 59 1/2.  Because of this, most individuals who buy annuities tend to be closer to retirement.

However, if you have maximized contributions to your 401(k) or individual IRA and still have other savings to invest, then an annuity could be an option.

If you are already retired and are no longer making contributions to a 401(k) or IRA, you might consider utilizing a tax-free transfer of assets from your retirement plan into an annuity, if your plan is to use the assets as a supplement to Social Security and any other sources of retirement income you may have.  This strategy will protect the principal from investment losses, generate a guaranteed lifetime income stream and potential death benefit. There is no "one size fits all" when it comes to annuities and you may find it helpful to consult with a licensed professional who has significant annuity experience.


 ARE ANNUITIES GOOD FOR SENIORS?

Will Social Security be "enough?"  Do you have an employer sponsored pension?  Have you accounted for estimated healthcare costs? What about sequence of returns risk?  As a society, we are becoming increasingly more dependent upon our own savings to supplement our needed income in retirement.

Considering the fact that the IRS imposes a fee on withdrawals taken from an annuity before the age of 59 1/2, annuities, particularly the ones offered by James D. Orr (fixed/fixed indexed) are generally purchased by individuals closer to retirement who are looking for principal protection, volatility protection and ultimately income protection. 

Annuities provide a guaranteed lifetime income to supplement Social Security but if properly structured may also provide a death benefit to your heirs or help offset long term care costs.  Forbes Magazine has referred to annuities as being the Swiss Army Knife of retirement planning.1

 

WILL I INCUR TAXES BY MOVING FUNDS INTO AN ANNUITY?

In most cases, funding an annuity is not a taxable event but it is important to know that the nature of the funds as well as the structure of the contract may have an impact.  If someone suggests that you purchase an annuity, please have your tax advisor ensure that you will not incur a taxable event by putting money in an annuity.   If you have cash in savings that you use to fund the annuity, you will not be taxed on the money that you add and the policy will grow tax deferred, meaning that you will not pay taxes on any gain until you begin to withdraw money.

If you are transferring funds from a qualified plan such as a 401(k) or IRA, then you avoid taxation of those funds by transferring through a direct rollover or transfer of assets. This is an IRS process rule that enables the funds to move directly to the annuity account without penalty or taxation. If you are moving cash value from a life insurance policy or money from another annuity that is "non qualified," a tax free transfer can be executed through the use of a 1035 exchange.

Whether your annuity is qualified or non-qualified, the interest in deferred annuities grows on a tax deferred basis, meaning you will not owe taxes until money is withdrawn, at which point the "growth" portion of the withdrawal will be taxed as ordinary income.  Depending upon contract provisions and the way your policy is structured will determine how your assets are taxed at withdrawal.

 

WHAT BENEFITS DO ANNUITIES PROVIDE THAT MY 401(K) OR IRA (If NOT IN AN ANNUITY) CANNOT?

A guaranteed lifetime income stream that can protect those who outlive expectations.  Think of an annuity as a "personal pension."

Annuity death benefits bypass probate and are paid directly to heirs.

Unlike 401(k) accounts and other investments, fixed & fixed indexed annuities generally do not impose fees although additional "riders" may be available for fee.


 WILL MY ANNUITY LOSE MONEY WHEN THE MARKET DECLINES?

Variable annuities and registered indexed linked annuities are securities and are subject to potential market loss and volatility. Traditional fixed annuities, multi-year guaranteed annuities, fixed indexed annuities and single premium immediate annuities are not subject to market declines, as those funds are not directly connected to the market. With a fixed indexed annuity, any growth in the account will be tied to a market index and may offer either a "participation" rate of the index growth, a "cap" on gains or may include a "spread."  With fixed and fixed indexed annuities, your principal is generally sheltered from loss (although early withdrawal fees may be imposed and could invade principal on some contracts).


IS IT TRUE THAT FIXED INDEXED ANNUITIES CANNOT LOSE MONEY?

Adding the word "indexed" to this product can be a little confusing as the assets are not directly invested in the chosen index.  Fixed indexed annuities are fixed annuities, not variable.  Negative performance in the chosen index (or indicies) will not erode the contract's cash value but be careful when you hear the claim that you "can't lose."  If you cancel early or take out more money than is contractually allowed during the surrender charge period, there are some contracts on the market that may eat into principal.  While fixed and fixed indexed annuities shelter you from market risk, discuss liquidity risk with your advisor before putting money into an annuity.


WHY DON'T INDEXED ANNUITY OWNERS PARTICIPATE IN INDEX DIVIDENDS?

Dividends are paid to the owner of a security, no someone who holds a call option on it.  Insurance companies that issue fixed indexed annuities typically buy call options in order to provide indexed linked interest to the consumer.  As the insurance company does not receive the dividends either, neither does the annuity owner.

 

ARE MY FUNDS LOCKED UP AND UNABLE TO BE ACCESSED WITH AN ANNUITY?

Deferred annuities have surrender fees (which may be referred to as contingent deferred sales charges). The purpose of these fees is to ensure you allow the annuity to accumulate value before it is annuitized for income distribution.  Many deferred annuity contracts will allow withdrawals annually that are free of the surrender charge, typically 10% of the account value.  


WHAT ARE "SURRENDER CHARGES" AND WHY DO THEY EXIST?

Surrender charges are responsible for many annuity sales complaints as they are often not thoroughly explained.  Before buying an annuity, please make sure you have a complete understanding of contingent deferred sales charges and how they work.  They are there for a reason and they don't need to be thought of as a "bad thing."

An insurance company incurs aquisition costs when it issues an annuity.  These costs can include printing & issue, agent commission, annuity guarantee expense as well as State mandated reserve requirements.  Annuities are designed to be longer term instruments and when one is cancelled "early," the insurance company traditionally experiences losses, why there is a need for a contingent deferred sales charge.


 HOW ARE INCOME PAYMENTS DETERMINED WITH AN ANNUITY?

The way income is paid out is a choice you make. If married, you typically may want to choose a joint-survivor option. At the passing of one spouse, the surviving spouse continues to receive a reduced income payment for life. There are several other options to consider, and it’s best to review these with your agent, as it depends on your individual situation.

 

HOW CAN MY PRINCIPAL BE GUARANTEED WITH AN ANNUITY?

With fixed and fixed indexed annuities, your money is not directly invested in the market. The insurance company’s general account is invested heavily in bonds for security and in return you are often given a guaranteed minimum rate of return on your principal.

Insurance companies are required by law to retain cash reserves to offset claims payments, which annuities are classified within. This is why it’s important to only work only with highly rated carriers, as these companies have the highest performing financial stability and strongest future outlook.


WHAT IS A MARKET VALUE ADJUSTMENT?

A market value adjustment is a contractual stipulation associated with fixed deferred annuities. An annuity can be structured in a variety of ways, but fundamentally it entails an upfront premium payment in exchange for a guaranteed income stream, which begins at a future date and lasts for a specified period, the remainder of the annuitant's life, or a combination of the two.

The period between the purchase of an annuity and the beginning of it's income stream is known as the accumulation period. During this period, the money in the annuity grows on a tax-deferred basis. While the annuity owner (annuitant) may be able to decide when to begin the income stream, to avoid a penalty they generally must wait a specified amount of time. This period is known as the surrender period.

Essentially, a Market Value Adjustment (MVA) is a monetary adjustment that can be applied to an annuity contract if the annuitant makes withdrawals beyond allowed limits during the surrender period.

MVA terms and computations vary widely, but they inevitably reflect an inverse relationship with interest rates. If you withdraw more than permitted when interest rates are rising, you will most likely experience an unfavorable MVA. If you withdraw more than permitted when interest rates are falling you could experience a favorable MVA.

An MVA can never reduce the cash surrender value of an annuity below the minimum guaranteed in the contract. Furthermore, an MVA will not apply to amounts withdrawn under a penalty-free provision or amounts withdrawn following the surrender period.



Some questions to ask an advisor before getting into an annuity

  • Why are you recommending this annuity?
  • What kind of annuity are you suggesting?  Fixed? Variable?  Immediate? Deferred?
  • Will the insurance company providing the annuity be able to make good on its promises? What are the company's ratings?
  • How much will this contract cost annually, including all expenses? What are the fees (if any)?  Are there riders you would suggest and what are the fees?
  • Does this contract have a guaranteed minimum rate of return?  If so, what is that percentage?
  • Should I buy mutual funds or an annuity? Both options have advantages and challenges. Mutual funds are generally less expensive but do not offer any guarantees. ...
  • Is the annuity adjusted for inflation? If you're still relatively young (which in the world of annuities means less than 80), ask about inflation adjusted or inflation protected options. ...
  • What are guaranteed retirement income benefits and settlement options available when it is time to enter the distribution phase? 
  • What is the surrender period? If there is a withdrawal amount free of surrender each year, what is that percentage?
  • Does this annuity include a Market Value Adjustment?
  • If a fixed indexed annuity is recommended....how is my interest credited at the end of each period?  Are there participation rates?  Are there caps?  Is there a spread?
  • If an income rider is added...how much will this rider cost, how is the cost calculated and how does the addition of a rider affect my ability to take the annual 10% "free" withdrawal?
  • Why should I work with you?

James D. Orr - Certified Annuity Specialist

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Annuities & Retirement

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15 Ways Fixed Index Annuities Are The “Swiss Army Knife” Of Retirement Planning (forbes.com)

Insurance and annuity policy terms and limits may vary by jurisdiction. Descriptions of coverages on these pages are limited by the terms, conditions, definitions and exclusion of individual insurance policy contracts. These examples are not representations of the law and are provided for informational purposes only. They are not intended to constitute legal, accounting or financial advice. Statements regarding potential liability or responsibility are based on general common law tort principles and/or standard statutes, both of which can be fact-specific and vary by jurisdiction. The general examples given here may not apply in every situation.  *Please note that the examples herein are neither company nor product specific and are concepts illustrated to give you general information of the benefits and limitations of the products and strategies and are not designed to be a recommendation to buy any specific financial product or service. Products change and such product concepts may not be suitable for your needs or available in your state. Please view the Disclosurepage for more detail and consult with an appropriate licensed advisor before putting money into an annuity.


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