Annuities: A Detailed Look

31 August 2015
 Categories: , Blog

You have likely learned about many different financial vehicles to use when you plan for your retirement income. One last piece of the retirement financial picture is annuities. Annuities are a highly complex investment tool, so it's important to learn how they are used and the way in which they function. 

This article will take a look into annuities in a realistic way to determine if they can fit into your retirement portfolio. You will learn that just like any other product, annuities are not bad in and of themselves; there are simply bad annuity products available for purchase. You will learn how to determine if this vehicle for wealth accumulation fits your retirement needs.

Misconceptions About Annuities

There is a common misconception that annuities are bad. Some CPAs encourage their clients to avoid annuities because of bad experiences in the past, and sometimes they're right. But there are also a handful of great annuities out there that are used for creating wealth. It's important to stay open minded. Looking at the financial crisis of 2008, many people invested in what they thought were good stocks and they ended up losing a significant amount of money. That made stocks look like a terrible product. But does that mean mutual funds and the stock market are bad and you should never put your money in there again? No. People aren't going to stop buying mutual funds just because of their product experience back in 2008 and early 2001.

Fixed vs. Variable

There are two types of annuities: fixed and variable. A fixed annuity is a contract between an insurance company and a customer, typically called the annuitant. The contract obligates the company to make a series of fixed annuity payments to the annuitant for the duration of the contract. Retirees often use a fixed annuity to provide a steady income for life. The fixed annuity focuses on protecting your principal. They are not tied to the market, they're just the fixed rate of return. The insurance company will guarantee you a certain percentage and it's tax-deferred. The challenge right now is that we are in a very low interest rate environment. You'll get a better return than on a bank CD. Typically we are seeing a 1-3% return. The negative side is there is not a great return and your money is tied up.

A variable annuity is a tax-deferred retirement vehicle that allows you to choose from a selection of investments, and then pays you a level of income in retirement that is determined by the performance of the investments you choose. With a variable annuity, the risk is on your shoulders, not the shoulders of the company you bought it from.

Both options have one thing in common – you put your money in with an insurance company.  It's best to avoid the variable annuity because the risk is on your shoulders and there are high fees attached.

Variable Products

With these products you deposit money into a fund and choose from a variety of different investment vehicles within the annuity. There might be 5,10,20,40 different funds to choose from.  Insurance companies pay a fund manager at a bank or Wall Street to manage the assets. These managers buy mutual funds, sell, churn, and rack up significant fees. This is specifically where annuities get a bad reputation. Variable products are volatile and expensive and they are not recommended. 

Annuities may seem complicated but in reality they are simply an arrangement between two parties. One of them, usually an individual like you, pays some lump sum to a second party, usually an insurance company. After that, the insurance company gives regular payments to the individual for some period of time specified in the arrangement. Like any other investment product, annuities have advantages and disadvantages. Annuities are not bad, there are just bad annuities. It's important to research the company you buy your annuity from and determine if they have the key features you're looking for.

To learn more, contact a company like Fogel Capital.