Annuities 101

They aren’t for everyone, but rising interest rates are making annuitiesA financial instrument that pays the holder a guaranteed stream of payments. The annuity is funded by either a lump sum (one-time) or a series of deposits. Once funded, the sum is invested by the insurance company who sold the annuity (the accumulations phase). After a certain trigger (for example, the holder’s retirement or reaching a certain age) payments begin to be issued to the holder (annuitization phase). Annuity payments may be fixed or variable in both amount and in length (some pay out for a designated span of years, others until the holder’s death). look more attractive for a subset of investors and others seeking retirement income.

Let’s begin with the basics: At its core, an annuityA financial instrument that pays the holder a guaranteed stream of payments. The annuity is funded by either a lump sum (one-time) or a series of deposits. Once funded, the sum is invested by the insurance company who sold the annuity (the accumulations phase). After a certain trigger (for example, the holder’s retirement or reaching a certain age) payments begin to be issued to the holder (annuitization phase). Annuity payments may be fixed or variable in both amount and in length (some pay out for a designated span of years, others until the holder’s death). is an agreement you make with an insurance company where you pay them and then they pay you back over time. You purchase the annuity contract either with a lump sum or via a series of payments. In return, the insurer commits to making one or more payments to you, which can last up to your lifetime or that of your spouse (for a fee, of course).

Two major factors distinguish one annuity from another: The timing of payments to the insurer and the timing and type of payments you’ll receive.

The timing of payments is based on which of the below annuity types you select:

• Immediate annuity: Payments on an immediate annuity (also known as an “income annuity”) must begin within one year of purchasing the contract. Immediate annuities are always purchased with a single lump-sum payment.
• Deferred annuity: This annuity type is purchased with either a single lump sum or a series of payments. Payouts to you begin on a future date you select—you may have the option to receive a single lump-sum distribution, to receive a series of payouts until the annuity is exhausted, or to annuitize the contract and receive payments for life. While you wait, your money in the annuity grows.

Your payments can take the following forms:

• Fixed annuities: Predictable and steady, fixed annuities offer a guaranteed interest rate and a fixed payment amount based on your initial lump-sum investment. As rates rise, this means you may end up getting more income from the same premium. The trade-off with fixed payments, however, is that you might not benefit from any market growth. Also, inflation is not your friend if you own a fixed annuity. Payouts can be for a set period of years or for life.
• Variable annuities: You select among investment options, often mutual funds, for preservation, growth or a combination of the two. You can make a single investment or add to your variable annuity over time. Your payout is determined by how your investments perform and can be taken over a set period of time or for life.

One big disadvantage to annuities is that they can be expensive, and you may incur substantial fees or penalties if your circumstances change and you need to withdraw your money ahead of schedule. Withdrawals made from your annuity before you reach age 59½ trigger a 10% penalty, and you’ll owe income tax on any earnings. Most contracts also include a “surrender charge” of anywhere from 7% to 20% on withdrawals made within the first five to seven years of purchase.

At Adviser Investments, we are extremely selective when it comes to annuities. An annuity may make sense if you’re concerned that you’ll outlive your assets. And we’ve found that they are a good fit for some of our clients. But generally, we believe that with consistent savings and well-built investment and financial plans, you can grow an asset base that will sustain you in retirement without taking on the high costs of annuities.

If you have any questions about whether an annuity is right for you or about the ins and outs of an existing annuity contract that you own, please contact your wealth management team and we’d be happy to discuss them with you.