Understanding how annuities work and choosing the right kind of annuity are the key parts of protecting your money from market losses. At First Benefits Group, Inc. one of our missions is to protect our client’s assets from risk. Therefore, we do not work with Variable Annuities. Except for a brief description of variable annuities, the information contained herein will specifically address Fixed and Fixed Indexed Annuities.
What Are Annuities?
Annuities are contracts with an insurance company which make a series of income payments at regular intervals in return for a premium or premiums you have paid. Most often annuities are purchased for retirement income. Only annuities can guarantee income payments to last as long as you live.
Annuities are valued by adding the premiums paid less any applicable charges, plus the interest credited. This value is used by the insurance company to determine the amount of the benefits that you can receive from the contract.
A deferred annuity also has tax benefits. The interest earned is tax-deferred as long as it is not paid out. Once the payout period begins, earnings will be taxed.
There are two main types of annuities.
With a Fixed Annuity, your money (less any applicable charges) earns interest at a rate determined by the insurance company which is spelled out in the annuity contract. This means that the insurance company guarantees it will pay no less than a minimum rate of interest. Once the payout period begins, the amount of each payment is set and will usually not adjust.
A Variable Annuity is an investment. Your premiums are invested into separate accounts and you choose how much risk you wish to take by selecting from stock, bond or other accounts that have no guarantees and are subject to market loss, or a fixed account with a minimum guaranteed interest.
During payout, your income may be fixed (set at the beginning) or variable (changing with the value of the investments in the separate accounts).
Declared Rate or Multi-Year Guaranteed Annuity (MYGA)
Fixed Indexed (FIA)
How a Fixed Indexed Annuity Works
A lot of people wonder if their money is really safe when they put that money in an annuity.
To ensure the safety of your money from market volatility, the first thing you have to do is look at the type of annuity you are considering purchasing. The type of annuity that we are discussing is a fixed indexed annuity. Money is protected from market losses in a fixed indexed annuity. The carrier that issues the annuity guarantees that your contract value never falls due to the associated index falling.
The money you put in the annuity becomes the initial contract value. The only way that the contract value can go down is if you withdraw money from the annuity, so let’s assume you make no withdrawals. Even if every financial market in the country plummets, your contract value stays exactly the same. It doesn’t decline.
Also, depending on the time commitment you are willing to make, some carriers offer products with a premium bonus that can be credited to your contract value as well. Currently, available premium bonuses can range from 5% to 11% of the amount that you put into your annuity.
Then, the annuity credits interest, typically annually, on contract anniversaries. There is an index upon which interest crediting is based, and if that index goes up, interest is credited, and once it is credited, it becomes a protected part of the contract value as well.
As anything is added to the contract value, whether it is the initial premium, any subsequent premiums, any premium bonus, or any subsequent interest credits, they are all contractually protected from loss due to fluctuations in the associated index by the issuing carrier. That’s what makes fixed indexed annuities so attractive and so safe.
The other element of safety is the annuity carrier. You need to keep in mind that a promise of safety is only as strong as the insurance carrier making the promise. Thus, you want to do some research to make sure that your annuity carrier is financially strong. Fortunately, there are independent companies, such as A.M. Best, Standards & Poor’s, Moody’s, and Fitch that analyze the strength of annuity carriers and publish their findings. Guarantees provided by annuities are subject to the financial strength of the issuing insurance company. Annuities are not guaranteed by any bank or the FDIC.
With a fixed indexed annuity, you are getting contractual guarantees, and such guarantees from a strong annuity carrier mean that your money is safe in a fixed indexed annuity.
Understanding Annuity Liquidity Features
Annuities typically have penalties associated with early withdrawal, called surrender charges. You may wonder why these charges are so prevalent in annuities. The reason is that carriers need them in order to provide you with the safety features and attractive interest rates of the annuity.
Consider your checking and savings accounts. Your money is safe and accessible in these accounts, but what interest rate are you receiving. Zero, or something extremely low, right? If you wanted to get a higher rate of interest on your money, what product would your bank offer to you? The answer is a certificate of deposit, which provides a higher interest rate, but it requires that you accept a penalty for early withdrawal.
Thus, you can see from your bank that if you want safety and an attractive interest rate, you need to sacrifice some access to your money, at least for a period of time. There is no financial product that will give you bulletproof safety, the potential for a high rate of interest, and full access to you money all the time – it can’t be done!
So, if safety and the potential to earn a high rate of interest are important to you, it makes sense for you to compromise a bit on liquidity for a portion of your retirement savings.
Now, let’s consider an annuity with a ten-year surrender charge period. Does that mean that you can’t touch any of your annuity money for ten years? Fortunately, almost all fixed annuities offer some access to your money, even during the surrender charge period. It is common for annuities to provide an annual penalty-free withdrawal amount equal to perhaps 10% of your contract value or your accumulated interest. There are also often provisions for the surrender charge to be waived in the event of certain hardships, such as nursing home confinement, diagnosis of terminal illness, or death.
Because of the surrender charge aspect, annuities are appropriate for a portion of your retirement savings, not typically for your entire retirement savings. Keep in mind that the existence of the surrender charge enables the carrier to give you want you want – safety and higher interest crediting potential – thus the surrender charge ultimately provides benefits to you.
Five Reasons to Consider a Fixed Annuity
If you are like many investors who wish to reduce or eliminate volatility, or are looking for a guaranteed minimum rate of return, fixed annuities are a great option.
Here are the top five reasons Fixed Annuities may be an alternative for your hard-earned money:
Fixed annuities can ensure that if anything should happen to you, your surviving spouse has a source of continued income in place.
This can help in case of a catastrophic illness or if you or your spouse needs to enter a nursing home.
Today’s volatile and challenging economy has heightened interest in liquidity.
Many people may hesitate to make long-term financial commitments without having flexibility and access to their funds, including creating an income stream should they need it.
The tax benefits of fixed annuities offer yet another positive attribute.
Because earnings will not be taxed until withdrawals are made or regular distributions start, fixed annuities provide the benefit of triple compounding: earning interest on principal, interest on interest, and interest on tax savings!
Another appealing aspect of fixed annuities is the ability to choose a predictable income stream.
Lifetime income options allow the fixed annuity owner to have control over the payment options that are guaranteed to continue for the duration of their life.
Peace of Mind
Fixed annuities are a great avenue for providing security to loved ones in the event of a death.
Annuities can help an estate avoid probate, allowing beneficiaries to receive annuity proceeds without delays and probate expenses.
Annuities are not right for everyone. At First Benefits Group, Inc. we follow a specific process to determine whether a fixed annuity is a potential option for each client. For more information on our process, please visit our Financial Services page.
For more information on Fixed Annuities or an appointment to discuss your personal situation, please contact firstname.lastname@example.org or 941.361.3057 x4.