Mention the word “annuity” to an investor, and you’re likely to receive mixed reactions. The concept is often misunderstood, leaving the everyday investor who is planning for retirement concerned that their money will end up tied up and inaccessible — and subject to market losses. But this isn’t an accurate characterization.
The following is a summary of the basics. The range of annuity products is broad, running the gamut from very simple to deeply complex. Like all the investment options we have, they have their pros and cons — or as I like to say, every rose has its thorns. Here are the basics:
What are annuities?
Annuities are contracts issued by insurance companies that can be used by investors to accumulate wealth and/or create a stream of guaranteed income for a period of time (for example, 10 or 15 years, or even a lifetime). You can fund an annuity with all types of money and accounts, such as an IRA, Roth or money transferred from a savings account.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
What types of annuities are available?
There are several types of annuities out there for investors. Choosing the right one comes down to your retirement goals and income needs. When do you plan to retire? What do you anticipate your minimum income requirements will be in retirement? How averse are you to market risk? Here’s a breakdown of your options.
First off, annuities can be broken down into two categories, based on when payments start:
- Immediate: Payments begin as soon as the investment are made.
- Deferred: The investor commits their money to the annuity for a certain period of time, such as five, seven or 10 years, after which they can either take it out as a lump sum, move it somewhere else or start payments. As part of this, there is a “surrender period” during which early withdrawals may be subject to penalty fees.
Beyond that, annuities come in three different types, based on how they are paid.
- Fixed: Similar to CDs*, these are the simplest type of annuity to understand. Under the terms of a fixed annuity, you commit a sum of money, and the annuity provider guarantees a yield. As an example, a 65-year-old woman is in need of dependable income to supplement her Social Security. She can take $200,000 and give it to an insurance company, which in return supplies a monthly income of $1,100 for the rest of her life.
- Indexed: These become more complicated. You commit your money to a similar time period, but you may earn a yield within a range, usually dependent upon a market index. There are many nuances that need to be understood, as the terms of an indexed annuity (that is, how much yield you might see) can vary from carrier to carrier. For example, there may be a cap on the index’s returns, or there may be certain returns that are not included in the annuity (e.g., dividends). Moreover, there are a variety of riders (such as guaranteed income options or death benefits) you may opt for as part of the annuity, which introduces further complexity. There are many moving parts to an indexed annuity, so it is important that you study up and work with an adviser to determine if it is right for you.
- Variable: To fully explain these would demand much more space. Suffice it to say, these are where significant complexity enters the equation. Returns are based on the performance of the funds you choose to invest in, versus an index. You may also consider purchasing riders. Variable annuities can be compelling, but only if you are willing to put in the time to properly educate yourself on how they work.
The Potential Downsides
So, what are the thorns on the annuity rose? Complexity is certainly one of them, but others include a possible lack of liquidity and fees.
Liquidity: Annuity contracts can restrict your access to your money. With immediate annuities, you cannot withdraw your funds once they are handed over to your insurer; you can only take the income payments. With deferred annuities, you may withdraw funds — up to a certain amount of the principal, depending on the contract — during the surrender period; however, as noted above, you may be subject to fees if your withdrawals exceed the amount permitted by your contract.
Fees: Fixed and immediate annuities seldom have any fees, but occasionally they may have a “market value adjustment” that can add to early withdrawal penalties. Variable and indexed annuities may have significant fees — and in the case of indexed, those fees may be deducted from your payouts — and they have to be weighed against the benefit you are deriving.
In summary, annuities may or may not have a place in your long-term plan. Approach them with an open mind. Some investors may immediately dismiss them because of what they have read or heard, but annuities can be attractive to investors who want to protect some of their portfolio from another serious market downturn. They can also be attractive for people in need of dependable cash flow.
All investment options have benefits and drawbacks. It is incumbent upon all of us, however, to educate ourselves and take control of our financial decisions.
Jamie Letcher is a Financial Advisor of CUNA Brokerage Services, Inc. member FINRA/SIPC, a registered broker/dealer and investment advisor.The opinions expressed those of the author and do not necessarily represent the opinions of CUNA Brokerage Services, Inc. or its management.This article is provided for educational purposes only and should not be relied upon as investment advice.
*Note: There are distinct differences between fixed annuities and Certificates or CDs. Most CDs are considered a short-term investment. An annuity is considered a long-term investment. The investment in a CD is insured by the federal government, either through FDIC or NCUA. The investment in a fixed annuity is guaranteed by an insurance company. Like CDs, fixed annuities have a penalty for early surrender, and withdrawals taken before the age of 59½ from an annuity may be subject to a 10% federal tax penalty.
CUNA Mutual Group is the marketing name for CUNA Mutual Holding Company, a mutual insurance holding company, its subsidiaries and affiliates. Annuities are issued by CMFG Life Insurance Company (CMFG Life) and MEMBERS Life Insurance Company (MEMBERS Life) and distributed by their affiliate, CUNA Brokerage Services, Inc., member FINRA/SIPC, a registered broker/dealer and investment advisor, 2000 Heritage Way, Waverly, IA, 50677. CMFG Life and MEMBERS Life are stock insurance companies. MEMBERS® is a registered trademark of CMFG Life Insurance Company. Investment and insurance products are not federally insured, may involve investment risk, may lose value and are not obligations of or guaranteed by any depository or lending institution. All contracts and forms may vary by state and may not be available in all states or through all broker/dealers.
MGA-2240257.2-1118-1220 ©2018 CUNA Mutual Group
-
Time to Spring-Clean Your Finances: A Financial Professional's Four Steps to Tidy Them UpA midyear review of everything from spending to saving, with adjustments as needed, can set you on track to financial security. Plus, don't forget to check in on your workplace benefits.
-
Why a Law Firm Secretly Recording Client Conversations Is Wrong (and Illegal)A law firm that has been recording client conversations without the clients' knowledge or permission and has threatened employees if they speak out faces legal and ethical challenges.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
