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Is An Annuity Suitable For My Financial Plan? Thumbnail

Is An Annuity Suitable For My Financial Plan?


There are many different ways to save for retirement. Some people save in employer-sponsored plans, IRAs and brokerage accounts. However, an annuity is another way to invest your money that many people do not know about. If you’re new to investing, or even new to the United States, you may be unfamiliar with the terminology surrounding annuities.

Annuities are insurance-based products that can be used to save for retirement in a tax-advantaged manner. They provide a periodic payment that can be fixed or variable for a specific period for someone’s lifetime. Annuitization occurs when the annuity owner elects to convert the money in an annuity into a stream of periodic income payments. In this case, the periodic income payments could be used for retirement.

Each person’s situation is different. So, an annuity won’t be suitable for every financial plan. However, in this article, the characteristics of annuities, types of annuities, and suitability for an annuity will be discussed. With this knowledge, you will be able to make an informed decision.

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Characteristics of Annuities

There are quite a few characteristics that set annuities apart from other investment vehicles. Learn these essential differences to see if it’s the right fit for you.

Immediate or Deferred

An annuity can have a payment that begins immediately or is deferred. An immediate annuity is one that is purchased with a single premium, and income benefits begin immediately, or very soon after the premium is paid. On the other hand, a deferred annuity defers annuitization until some point in time chosen by the owner

Different Settlement Options of Annuities

  1. Fixed period- The payments continue to the annuitant for a specified term and to a designee if the term exceeds the annuitant’s life. The insurer determines the amount of the payment that the designee will receive.

  2. Fixed amount - A fixed amount is when payments are made periodically in a fixed amount determined by the annuitant. The insurer only determines the length of time for which the payments are made.

  3. Straight life annuity - This is where the payments continue until the death of the annuitant.

  4. Life annuity with period certain - The payments in this type continue to the annuitant for the annuitant’s lifetime, but if their life is shorter than the guaranteed term, the payments will continue to a designee for the remaining term.

  5. Joint and survivor annuity - This type will have the payments continue until the death of the last of the two annuitants.

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Premium Payment Method (Single or Periodic Premium Payments)

  1. Single premium deferred annuity (SPDA) is a lump-sum premium with an annuitization period deferred until a certain point in the future. The premium can earn interest that accrues tax-deferred.

  2. Flexible premium deferred annuity (FPDA) allows periodic, non-fixed contributions. The earnings can accumulate free from current income tax and are then distributed in the future.

  3. Single premium immediate annuity (SPIA) allows the annuity payments to the annuitant to begin one payment following the premium payment.

Contract Riders, Provisions, and Recommendations

Common riders that insurance companies have advertised include:

  1. Guaranteed step-up death benefit rider

  2. Long-term care coverage rider 

  3. Guaranteed lifetime withdrawal benefit (GLWB) rider

  4. Guaranteed minimum withdrawal benefit (GMWB) rider

  5. Guaranteed minimum income benefit (GMIB) rider 

  6. Guaranteed minimum accumulation benefit (GMAB) rider

Basic Provisions

Annuities come with basic provisions which can include a free withdrawal up to 10%-15% of the contract’s accumulated value. They also offer a surrender charge that is imposed when the full value of the annuity contract is withdrawn to deposit elsewhere. Crisis waiver or surrender charge waivers are also provided for death, disability, nursing home, terminal illness, unemployment.

Surrender Charges

A surrender charge period can vary from 0 to 15 years. A surrender charge schedule defines the amount of the surrender charge a client will pay if he withdraws the fund before the end of the surrender charge period. Surrender charges can be as high as 8% of the amount withdrawn depending on the terms of the contract. Surrender charge schedules and fees vary from one insurance company to another. 

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Types of Annuities

Read on to learn more about the six types of annuities available to invest in for retirement purposes.

Fixed Annuity

A fixed annuity is where premiums paid into it are invested in the account of the insurer. However, the insurer bears the investment risk, and the annuitant typically receives a minimum guaranteed interest rate. Upon annuitization, the fixed periodic payment is determined based upon the form of the annuity. A fixed annuity is generally more suitable for a more conservative investor.

Variable Annuity

A variable annuity is when the premiums paid into it are invested in sub-accounts that are directed by the owner. This type of annuity is only suitable for investors who have higher risk tolerance. The income upon annuitization depends on the performance of the subaccounts. A variable annuity benefit could result from a single premium or flexible premium and can be immediate or deferred. The owner of the annuity directs the investment of the contract’s cash value among available subaccounts and bears the risk.

Equity-Indexed Annuity (EIA)

An equity-indexed annuity (EIA) is a contract that is credited with a return based on changes in an equity index. The insurance company typically guarantees a minimum return that can vary depending on the issuing company. This type of annuity combines a guaranteed minimum return with the ability to earn a return linked to equity markets. This can be suitable for those who want to participate in the equities market without the investment risks or costs of a variable annuity.

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Bonus Annuity

Bonus annuities offer a bonus in the form of a credit that may be added to the initial premium or investment. Insurance companies offer bonuses to give potential annuity clients an incentive to choose their annuity. Any type of annuity that offers a bonus based on the percentage of the premium paid is known as a bonus annuity. The disadvantage of a bonus annuity is that they generally have longer surrender charge periods and higher annual management fees.

Deferred Income Annuity

A deferred income annuity (DIA), which is also known as a longevity annuity, starts with choosing a future income start date. The elected start date can be anytime after the first contract year and up to age 85. Purchase rates are also established at the time of the initial premium payment.

Qualified Longevity Annuity Contracts (QLACs)

Qualified longevity annuity contracts (QLACs) are an insurance option that ensures retirees have a stream of regular income after they retire. The participants can use up to 25% of their account balance or $125,000, whichever is less, to buy a QLAC. The maximum age at the commencement of income of the annuity starting date has to be no later than the first day of the month following the employee’s attainment of age 85.

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Should I Consider an Annuity?

When considering if you should invest in an annuity, you should question whether you are maximizing the use of other retirement accounts first. For instance, variable annuities are not the only investment vehicle that can provide tax-deferred growth. You may be eligible for an employer-sponsored plan or IRA instead.

In general, investing in an annuity will not give you any tax benefits. So, if that is a high priority for you, reach out to your financial planner to determine other options. Also, keep in mind that annuities have fees and surrender charges that you should be aware of. Take a detailed look at any terms and conditions of an annuity before committing. 

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