Understanding Different Types of Annuities (and 3 Smart Questions to Ask)

Understanding Different Types of Annuities (and 3 Smart Questions to Ask)

Americans are faced with many options when it comes to saving for retirement and wading through all of these choices can be a daunting task. There is no one-size-fits-all plan when it comes to how you should manage your savings, and maximizing your own retirement dollars may mean a tiered strategy with different types of accounts.

When it comes to retirement planning, many individuals will use their 401k’s and IRA’s as their primary source of income after working; however, those with extra money to invest beyond the contribution limits of a 401(k) or IRA may look for other tax advantaged investment vehicles, such as annuities.  The primary reason why? There is no contribution limit! But this does not mean annuities are free of “cons” or drawbacks—they certainly have a few. Let’s explore the different types of annuities and the basics of how they work.

What Is an Annuity?

Annuities, such as fixed-indexed annuities, income annuities, and variable annuities, are ultimately a contract between you and an insurance company. You are effectively paying that company for a fixed income stream in your retirement.

As is the case with any contract you sign, you must read all of the fine print when it comes to an annuity, and this means asking lots of questions, too. We’ll get to some of those questions shortly. First, we will explore the characteristics of the different types of annuities and how they can impact your investment.

Different Types of Annuities

You will hear a number of different descriptive terms associated with annuities, but let’s think about dividing those terms into the categories of how you INVEST and DRAW INCOME.

In terms of how you invest, annuities can be FIXED or VARIABLE. As you might guess from the names, “fixed” annuities are the more conservative option of the two, preferred by those who are risk averse or do not want their investment to be subject to market volatility. Your interest rate and annual annuity pay out is guaranteed by the insurer. In a variable annuity, you take on greater risk, and possibly a greater reward by investing in a portfolio of mutual funds. You direct the insurance company to invest your money into a number of funds on your behalf. So the performance of your portfolio will be largely determined by the asset allocation that you construct as well as the performance of the individual funds you have chosen.

In terms of how you get paid, annuities can be IMMEDIATE or DEFERRED. Typically, immediate annuity pay outs will be chosen by investors who need to generate a retirement income stream now, whereas deferred annuity payments will be chosen by those looking to accumulate wealth in a tax advantage vehicle with the intention of creating income at a later date. Just as it is the case with a 401(k) or IRA, any growth within the annuity will be taxed when withdrawn from the annuity, whether the pay out is immediate or deferred.

This is just the tip of the iceberg when it comes to understanding types of annuity and buyers should be wary of rushing into an annuity contract without asking many questions.

Below are 3 important questions to ask any financial advisor in San Diego or Los Angeles:

How is the company rated?

We read restaurant reviews before taking the chance on a $50 meal so we should certainly take the time to review insurance companies before investing a whole lot more on an annuity. Take the time to review and research the insurance company to ensure it has a solid reputation and outstanding consumer ratings. A handy guide to insurance company ratings can be found here.

What is the TOTAL cost including EVERY fee?

This is one of the most commonly cited “cons” when it comes to annuities—the numerous fees that can be associated with them. You need a clear picture of every possible fee before you decide to buy. Fees can include commissions to the agent or broker, surrender charges (which you will pay if you pull the money out before the contract ends – typically 4-10 years) mortality & expense fees, administrative fees and annuity rider fees.

What are the withdrawal penalties?

Be sure you are clear on any and all penalties associated with the early withdrawal of your funds; Most annuities have surrender schedules to prevent investors from drawing all of their money out. A 7 year declining surrender charge schedule will typically look like this:

Year                     1     2     3     4    5     6     7

Surrender %      7   6     5    4     4     4     3

Most annuities have a 10% free annual withdrawal amount that is exempt from the surrender charge.

Is An Annuity Is Right for Me?

When it comes to determining whether an annuity is suitable for you, it’s important to understand how it fits within your financial picture. As you can see from this brief article—where we only skimmed the surface in of how annuities work—this whole process can be quite complicated and overwhelming for the average investor. When it comes to protecting your nest egg and maximizing your income in retirement, it’s important to understand all aspects of your financial situation including cash flows, taxes, your existing investment portfolio and your goals.

If you don’t have a clear understanding of all these areas of your financial situation, it may make some sense to work with a fee-only financial planner. While it may create an additional expense in the short-term, there is a tremendous amount to be gained in the long term.

Working with a financial planner to make decisions about annuities, mutual funds, 401(k) s, IRAs, and any other retirement strategies will ensure you come up with a balanced approach that will make the most of your situation.

Contact Satori Wealth Management

Speak with the team at Satori Wealth Management today to discuss your financial future.  We’re ready to help you understand the Safe Withdrawal Rate and make the right decision to live the retired life of your dreams.  Click here to contact our team today to receive a free consultation.

Sources and Additional Reading


Author: Danny Michael
Danny G. Michael has 17 years of experience as an advisor working with individuals, families and business owners. Danny has also been a Certified Financial Planner™ since 2006 and is also an Accredited Investment Fiduciary.

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