Annuities
Annuities are one of the most fundamentally misunderstood and possibly most oversold products in the financial services market.
At their core, annuities are insurance products and not investments. These products can insurance against several events such as they will insure a retiree never runs out of income.
This can make them a valuable part of a sound overall financial strategy heading into retirement.
There Are Many Types of Annuities
These annuities have a stated interest rate for a stated period of time. Such as 4.5% for 6 years.
There is not market exposure with this type of annuity and may operate most similarly to a multi-year CD. It makes them very predictable.
Variable annuities are products that do have exposure to market conditions through investment in sub-accounts. This can make the future value of the annuity volatile depending on the sub-account performance.
While sub-accounts may look like mutual funds, they are technically different.
A unique characteristic of Indexed annuities is their ability to participate in some market exposure via an index such as the S&P 500, while offer a 0% "floor" on your money.
In exchange for the 0% "floor" these often come with a "cap" on your overall performance. On the surface these products can seem simple, but can be fairly complex.
Similar to Indexed annuities, Registered Indexed annuities allow for participation in potential market gains via exposure to an index, such as the S&P 500.
However, the often differ in their ability to have higher caps, or uncapped, performance while offer limited downside protection. An example may be 100% participation in the S&P 500 Index but only 10% downside protection.
Immediate annuities operate most similar to a pension that one may get from an employer. In exchange for a lump sum premium payment the insurance company will offer varying degrees of steady income. The period this steady income will last for is predetermined and can cover one person, two people or a certain period of time.
Are There Downsides to Annuities?
Yes. As with any financial product, nothing is perfect. What can look like a pretty straight forward product can actually be quite complex and are most certainly not appropriate for all investors. Some of the potential downsides to annuities are as follows:
Annuities can be one of the most expensive ways to invest your capital. Remember they are insurance products.
Variable annuities can often times run into the low-to-mid 3% range in annual fees. These higher fees can prohibit growth. Make sure you are willing to pay for the insurance part of this type of product before purchasing.
Almost all annuities are non-liquid meaning you may have difficulty taking all of your money back should you change your mind.
This is due to most annuities having lengthy surrender periods, or a penalty for withdrawing all of your funds before a certain time period has lapsed. These can range between 5 - 12 years depending on carrier and product.
The only thing guaranteed in life is death and taxes. Annuities are no different. While they do have a "guaranteed" aspect to them, that guarantee is only as good as the insurance company issuing the policy.
While insurance company defaults don't happen often, defaults can certainly occur. It's important to choose a carrier with a strong history of financials. If it looks too good to be true, you should be asking more questions.
By their nature as insurance products, they may very well come with limited flexibility. Since these are insurance contracts, there are often times predetermined benefits that once started aren't easily changed.
Annuities with market exposure may also have fairly limited sub-account or index options for you to choose from. If flexibility is most important to you, then you may not be best served by utilizing one of these products.