Top 7 Things to Know About the Best Annuities
Thinking about investing? Keep reading to check out our 7 top tips for finding the best annuity for your needs.
Annuities are not for everyone, and many people will find that their money is best invested somewhere else. In the past, this was the norm. It was only a very specific audience that benefited the most by using annuities as part of their retirement or investment strategy. In the past few years though, this has changed dramatically. Annuities are far more beneficial today than they ever have been and they appeal to a larger number of individuals than they once did. That means that you are far more likely to use an annuity today than ever before, too.
With that in mind, we’ve put together all of the information that you will need to find the best annuity for your unique situation.
What is an Annuity?
An annuity is a life insurance product that is designed to help generate steady income during retirement. These come in many shapes and sizes, most of which we will explain below. Basically, an annuity is a way to provide lifelong income from your own savings and protect yourself from outliving that savings.
Social Security is a type of annuity. Once you start receiving benefits, you will keep receiving them month after month, even if you start receiving more money than you originally paid into Social Security when you were working. This is the Federal government’s way of helping older individuals have an income long after they have stopped working.
Other annuities are offered by private insurance companies. These will be the focus of our discussion here.
Things You Need to Know
1. New Annuity Types Have Changed the Game
Ten or so years ago, there were only a handful of different types of annuities. You had your fixed rate annuity, where you knew exactly what your rate of return was going to be year after year. There were also variable annuities, where your return was linked to the performance of the assets that were in your fund, much like how a mutual fund works. There were also index based annuities, where the performance of your money was linked to a major index, like the S&P 500. There was some variety within these types of annuities, but not much.
Today, newer products, such as structured annuities, have completely changed the annuity market. In a recent yearly survey of annuity sales, it was found that most annuity sales had dropped significantly, but the sale of structured annuities was up by over 20 percent.
A structured annuity works by absorbing some of your losses in exchange for limited gains. Let’s say that you have a loss protection of 10 percent per year, and the assets in your account drop by a value of 8 percent. In this case, your account will not lose any money. If they drop by 12 percent, your account will only go down by 2 percent. In exchange for this, you will have a cap on how much you can earn on a yearly basis. If that cap is set at 5 percent, and the market goes up by 8 percent, you will still only earn 5 percent. Still, this is a great way to limit your losses when the market looks uncertain, and still get many of the same benefits that a variable or index based annuity offers.
2. Not All States are the Same
Different states have different laws concerning annuities, and not all annuity or insurance products are available in every single state. For example, if you live in New York, you might find that you don’t have a specific product available that someone in Ohio has access to. This makes finding the right annuity for your needs a little bit harder, but certainly not impossible. Check out our state by state guide for more information on how to find the annuity that will best serve your purposes.
This can make things a little bit harder because what’s best in one state might not necessarily be best in another. Luckily, it isn’t too difficult to navigate this once you have a better idea of what you’re doing.
3. There are Variations Within Each Type of Annuity
All annuities give you some options to allow you to customize your investment. For example, there are both immediate and deferred annuities, usually within the same product. With an immediate annuity, you start receiving a monthly check right away, which is usually best when you invest a large money all at once. With a deferred annuity, your money is held in the fund for at least a year before payments begin. Depending on what you’re looking for, either can be very helpful.
Insurance companies also add different riders and other customization options to help their products appeal to more people. For example, with a structured annuity, your two main options include a buffer and a floor option. The buffer options absorbs the first losses to a limited number, while a floor lets the investor absorb the first losses, and then the company absorbs the rest. Which is better for you will depend on your personal situation.
4. You Need to Know Your Fees
Annuities might not have upfront fees, but you do pay for them. Basically, there are two main ways that you can purchase an annuity: from the company directly or from a licensed insurance professional. Both will earn money off of you, but you will need to do some work to figure out how much. The best way is to just ask. This isn’t secret information, and these individuals are obligated to share that information with you. Minimizing fees can be a good way to maximizing your returns.
Remember that lower fees do not necessarily equal better returns. A lot of low cost mutual funds which can be included in variable annuities have no active fund managers, and as a result, the returns can be pretty bad when the market is doing poorly, or even when the market is doing well. Looking at the past performance of the funds and annuities that you are thinking of before you sign any sort of document is essential if you want to get the most out of your annuity.
5.You Need to Know Your Payout Options
Typically, you don’t need to select your payout option until you annuitize your contract, but it’s always a good idea to know what the options that your insurance company has for you before you buy a contract. For example, you don’t want to buy an annuity that doesn’t have survivor payouts if you are interested in giving your spouse lifelong income after you pass away. Know what the payout options offered are before you commit to a contract.
Generally speaking, there are a handful of different payout options available to you. These include lifetime, guaranteed period, and survivor. In a lifetime annuity, you will receive a monthly payment for the entirety of your life. This can be beneficial or harmful. For example, if you purchase a $1 million annuity and pass away after a year of $1,000 monthly payments, there’s a lot of money left behind. But, if you buy a $50,000 annuity and considerably outlive your payments, then it has been very beneficial to you.
In a guaranteed period annuity, the monthly payments will continue for a previously agreed upon time period. This can extend into a survivor benefit for a limited amount of time.
With a survivor benefit annuity, the annuity will continue paying for the remainder of your lifetime, plus the entirety of the lifetime of your designated beneficiary. This is usually a spouse, which is why this annuitization choice is so popular amongst married couples.
Payouts will vary depending on the type of annuitization option you choose and a variety of other factors. Also, it’s important to keep in mind that the terminology that you come across can vary from company to company.
6. Know the Rules
Like all investment vehicles, there are rules and laws that govern how annuities function, especially when it comes to the payout. There are three general payout choices that you will come across. These include annuitization, systematic withdrawals, and a lump sum.
An annuitization option is what is thought of most frequently when annuities are discussed. This is the monthly payment option that you can select when it’s time to get payments on your investment. Once this process is initiated, it cannot be changed most of the time.
Systematic withdrawals can be a valuable option if you do not want to get stuck in the annuitization phase of your annuity. This is done when money is withdrawn from the annuity. It can be done on a regular basis or it can just be done on an as-needed basis. There may be tax and company penalties that can apply to this, especially if you are withdrawing money before the age of 59 ½.
A lump sum withdrawal is just what it sounds like. Once your money has been in the annuity gaining interest for a while, you may choose to never annuitize your investment and just withdraw it all at once. This can be a good option if you have a sudden large expense come your way, or even if you find a better investment opportunity down the road. It’s good to keep this option in mind, just in case something happens.
Again, things do differ slightly from company to company, so it’s important to know the rules and how they will impact your investment. Talk to an insurance rep if you have any questions regarding this topic.
One other rule to remember is the surrender period. This is something that will impact you if you are looking to take a withdrawal, either systematic or lump sum, out of your account. The surrender period is basically a penalty for withdrawing your money. Depending on the policy, the surrender period will vary in length. It could be as long as ten years, or it could be just a few. If you take money out of your annuity, you will pay a percentage of your annuity contract to the company.
Now, this can change on a tier system depending on how long you have held your annuity. For example, if you take a withdrawal out after two years, you might pay a 7 percent penalty, but after five years, you might only pay a 2 percent penalty. Your specific annuity will likely have a chart in the paperwork that explains the surrender period. It is important that you are aware of this before you commit to a contract so that there are no surprises in a couple years if you need access to that money.
There are a lot of great companies out there, but not all of them are going to be the best insurance company for you. With that said, there are a lot of larger companies that have a nationwide reach. Companies like AIG, Fidelity, MassMutual, American Equity, Prudential, and Pacific Life, and Allianz have national products available, and many of them have presences well beyond the United States, too.
Depending on where you live, there may be great smaller insurance companies that you can invest through, too. Be sure to search the specifics for your state so that you can get the best deal possible and find the perfect investment opportunity for your needs.
Once you have a good idea of what companies you want to work with and what is available to you in your state (see below), then you will want to start narrowing down your search by the reputation of the company. Both companies and individual annuities and funds are graded, and it’s always best to stay near the top of the list. This is your money that we’re talking about, and putting it in an inferior fund or trusting a company that has a poor reputation is not going to do you any favors over the long run.
Both the A.M. Best Company (www.ambest.com) and J.D. Power (www.jdpower.com) do a great job of rating companies. Taking a look at their periodically updated rankings will help you to form a better idea of which companies to trust and which to stay away from.
Start with Your State
If you’re ready to start shopping for the best annuity for your needs, you’ve come to the right place. Hopefully at this point, you know what you need to find in an annuity. If not, we have a brief FAQ section down at the bottom of this page.
Annuities need to be shopped for on a state by state basis. Here, you can search for annuities that are available to you in your respective state.
The specific insurance laws will vary from state to state. As a general rule, New York has some of the strictest laws in place to protect consumers, but not all states go above and beyond the federal regulations concerning consumer protection. Know how your state operates and how it could potentially impact your investment and retirement.
You’ve got questions about annuities; we’ve got answers. Here are some of the most frequently heard questions regarding annuities.
Won’t my retirement account do all the same things that an annuity would?
Not necessarily. Tax laws and distribution requirements vary depending on the type of retirement account that you have. Furthermore, not all retirement accounts can bypass the probate process for your beneficiary if you pass away. Because annuities are technically a type of life insurance, your beneficiary would receive annuity funds before the probate process begins, giving a grieving loved one access to your money more quickly. Not all retirement accounts can do this. Talk to a financial advisor to determine which type of retirement account will best serve your family’s needs.
How much control of my investments do I get with an annuity?
Depending on the annuity that you choose, you may have no control over where your money is invested, or you may have a high degree of control. Most fixed rate annuities give policy holders no control, but many of the variable rate policies allow you to choose from different risk profiles and specific funds so that you can get the most out of your investment.
Are there fees associated with annuities?
Yes. All types of investments have fees, and annuities are no different. Some have a highly visible yearly cost associated with them, while other annuities have more hidden fees because of an artificially low fixed rate. Even if you can’t visibly see the fee, your annuity will have a cost associated with it.
Who is an annuity best for?
There are a number of situations where an annuity would be a strong investing choice. The most common scenario is someone has already maxed out their IRA contributions for the year. Excess money can safely be invested into an annuity without tax penalty. Another common scenario where annuities are best used is when someone comes into a large sum of money, such as what might occur when a law suit settlement occurs or an inheritance comes into effect. An annuity can help with money management by creating a monthly budget.We also breakdown some of the different annuity types with a look at a fixed annuity vs. a variable annuity. You let us know what you think.
How much should I invest in an annuity?
The exact dollar amount that you invest in an annuity will vary from person to person. The general rule of thumb that many financial professionals will tell you is that you should be contributing enough to get the maximum matching benefit from your workplace 401(k) and maxing out your yearly IRA contribution. Excess savings can often be put to best use in an annuity because there are no tax limits on how much can be invested here. Of course, these rules do not apply to each and every individual out there, so if you have more questions about this specific topic, get in touch with a financial professional.
How can I pay for an annuity?
You have a few options when it comes to investing your money in an annuity. You can purchase one with a single lump sum payment, make ongoing contributions on a monthly or yearly basis into the account, or if you are already collecting Social Security benefits, you can even coordinate with the insurance company to have a portion of your Social Security go directly to the insurance company.
Do annuities have a mandatory distribution age?
Many retirement funds, like IRAs and 401(k)s require that you begin withdrawing money from your account if you haven’t already by the age of 70 ½. With annuities, there is no required minimum distribution age. With that said, different types of annuities may fall under the federal required minimum distribution law, especially if you are withdrawing money from another account to add to an annuity. Immediate annuities are exempt from this law, however. If you were to purchase an annuity and annuitize it immediately, then the remaining money in that contract would not be impacted by these laws.
This can be a complex area and walking through it carefully with a financial professional will ensure that you stay on the right side of the rules and regulations and do not expose yourself to unnecessary fees and penalties. Everyone is in a unique position and explaining your circumstances to a professional will ensure that you are following the steps correctly.
Finding the Right Annuity
Annuities aren’t for everyone, but if you’re in the market for this retirement option, then you want to find the right one for your particular situation. Knowing your needs, and knowing how that translates into the multitude of different annuity variations and choices out there will be a big help when it comes to finding the best annuity for you. Start with this, move on to what’s available in your state, and then start narrowing down your search by the reputation of the companies, and you will find that the search for the right annuity will suddenly go from an overwhelming task, to a much easier one.