By Peter Mastrantuono
The merits of annuities are highly debated among financial experts and commentators. What cannot be disputed is that annuities are the only investment that can guarantee lifetime income. Which is why so many Americans approaching retirement or already retired consider making an annuity a part of their overall retirement income strategy.
Annuities come in two basic forms—an immediate annuity in which a lump sum investment is exchanged for lifetime periodic payments and a deferred annuity in which a lump sum is invested prior to retirement, allowing money to grow tax-deferred until the annuity owner decides to convert it into a guaranteed stream of income for life.
There are several types of deferred annuities, including fixed-rate, variable-rate and index-linked annuities. Fixed-rate annuities promise a rate of interest, generally for a specified period of time. Index-linked annuity returns are tied to a designated index (e.g., S&P 500), while variable annuities offer pooled investment vehicles that generally invest in stocks or bonds whose rate of return is neither guaranteed nor predetermined.
Considering the number of annuity providers and the complexity of the product, individuals need to shop with care and should consider working with a financial advisor with the knowledge and experience to help evaluate annuity choices.
There are a number of key annuity features and attributes individuals will want to consider.
- The lifetime income guarantee of an annuity is only as sound as the long-term financial health of the insurance company issuing that annuity. Investors should only consider highly rated, financially strong insurers.
- When considering a fixed-rate annuity, individuals will want to look at the interest rate it pays, for how long that rate will be paid, and how subsequent interest rates will be set in the future.
- Variable annuities require a thorough review of multiple elements, including available investment options, investment restrictions, step-up benefits, and their annuitization options. For instance, variable annuities offer different guaranteed income options, including a guaranteed monthly income benefit (GMIB), which may protect future income from investment losses and a guaranteed minimum withdrawal benefit (GMWB), which guarantees income payments on the basis of a percentage of the original investment.
- For index-linked annuities, it is critical that investors understand the index to which returns are linked, the contract’s minimum guaranteed rate of return and the performance participation formula since they may differ from provider to provider.
- All deferred annuities come with varying fees and expenses, including mortality and expense fees (M&E), administration fees and surrender charges. Surrender charges are charged on withdrawals and generally phased out over a seven- or eight-year period. Comparing these fees is critical since they will impact net investment returns.
- If a death benefit is important, individuals should be aware that not all death benefit calculations are alike, so the formula for how the annuity calculates a death benefit ought to be reviewed.
Annuity evaluation is not for the faint of heart, but the effort will be worth it. For most Americans, working with a financial advisor may be the smartest approach.
Peter Mastrantuono is a contributing writer to www.myperfectfinancialadvisor.com, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.