All Annuities aren't the same

All Annuities are not constructed the same.  In the world of annuities some confusion rests with people not understanding the differences between the three main types of annuities.  There are Fixed Rate, Fixed Index and Variable Annuities.  

Fixed Rate Annuities pay a fixed rate for the life of the annuity or can reset, however most fixed rate annuities pay a set rate for the term of the annuity.  Fixed Rate Annuities are guaranteed to not lose principal.  There are no management fees, prior earnings are guaranteed as well (meaning progress is never lost) and there is a minimum interest guarantee.  These are largely dependent upon the interest rates of economic times.  

Fixed Index Annuities pay an interest credited to your account based upon some measure of index.  There are many options that exist including interest credited from the S&P 500 which include caps or rates of participation of those indexes.  The different types of interest crediting vary by insurance company.  There are many insurance companies who issue Fixed Index Annuities.  Fixed Index Annuities are guaranteed to not lose principal.  There are no management fees, prior earnings are guaranteed as well (meaning progress is never lost) and there can be a minimum interest guarantee.  The participation rates and caps can be largely dependent upon economic times.  

Variable Annuities are a different type of annuity.  They are registered as securities because their principals are NOT guaranteed.  There are management fees which can add up to 2-3% of your contract value.  Your progress in your annuity is NOT guaranteed.  Often there are sub accounts of funds (with fees) that act as the underlying investment vehicles within the variable annuity contract.  

There is another type of annuity that should be mentioned as well.  A Single Premium Immediate Annuity (SPIA).  When you purchase a SPIA the insurance company is providing you a guaranteed income for life or a period certain.  This is a pure income stream from a lump sum of money.  It is often used at the beginning of a retirement period or other life event.

All annuities have their purpose but as you can see are not built the same.  Often articles and critics lump all annuities as being expensive vehicles for people to consider.  Most critics do not understand the differences between the types of annuities and only focus their criticism on Variable Annuities because of the increased fees of owning them.  People who purchase them often are purchasing them for a time in their lives where they like or are recommended certain riders that might seem attractive.  People must seek out industry professionals who use annuities for their designed purpose.  That purpose is future income.  Annuities are most appropriate for a future income stream in retirement that can provide a person or couple with piece of mind that they have a monthly income to rely on.  

Most people who own Variable Annuities should be made aware that their annual fees are in the 2-3% range of their overall account value.  People should consider that, for example, a Variable Annuity owner who has $500,000 in their annuity is paying $10,000-$15,000 in annual fees to own the annuity.  Add that figure up, accounting for possible gain in your account value, and it is possible that a person who owns that annuity for 20 years is paying a total lifetime dollar amount of $200,000-300,000 in lifetime fees to own a future income stream that quite possibly could be achieved with other methods.  In my experience that is a lot of money for someone to pay just for a future income stream.  

Annuities can be a part of a sound retirement income strategy.  In times of higher interest rates, people might find fixed rate annuities as an important piece of their future income puzzle.  Likewise a person might find that owning a Fixed Index Annuity provides the opportunity for no annual management fees, guaranteed principal and still being able to participate in index gains by the use of interest crediting whereby there is some participation rate on the upside but no participation on the downside.  People should also consider that Fixed Annuites, Fixed Index Annuities and Variable Annuities come built with surrender charges for early surrender of accounts.  The surrender charges often begin higher (and often allow for a certain percentage of the account to be able to be withdrawn without penalty) and begin to decline with each year of ownership.  At some point the surrender charges disappear.  Surrender charges can be as high as ten years.  But people need to understand that most annuities are long term instruments.

The focus of this information is to educate you on the different types of annuities and how they operate.  Most people do not understand how they operate, even people currently invested in them.  A good practice for a person who is considering using an annuity as part of their retirement plan might be to consider how many years they might own that annuity.  Once you come up with a number - consider then writing down the annual cost of owning such an annuity, then take that 'fees' number and times it by the amount of years you expect to own the annuity.  For example you might be considering a 25 year ownership with $300,000 which will cost about $9000 per year to own that Variable Annuity.  So over 25 years you would pay over $200,000 in annual management fees to own that annuity.  Likewise if you used a Fixed Rate or Fixed Index Annuity it would cost you zero dollars in annual management fees over that 25 year period.  Now all things being the same - let's say you chose an annuity with a ten year surrender charge period.  Assuming you were owning that annuity for 25 years - there would be no surrender charges for any of the three annuities chosen provided you didn't make a sizable withdrawal within the allowable annual amount.  

Remember - your due diligence is paramount.  Make sure you choose the 'correct' type of annuity for you and your goals.  

As you can see I am not a fan of Variable Annuities as they are expensive to own relative to the benefits of what they provide.  We do not utilize Variable Annuities. They have their purpose for some people but I believe if you are choosing an annuity for a future income stream, then you are choosing the annuity for a 'future income purpose'.  Income is the purpose of choosing an annuity in the first place.  Variable Annuities are expensive to own.  Choose wisely.  Consult a professional who has your interests at heart that will find the most appropriate annuity for your needs.   We are here to help you find whether an annuity makes sense for you and your future.  

Brian Thomas Deegan