5 Questions to Ask Before Buying an Annuity
Annuities get a bad rap—and sometimes rightfully so. If you buy the wrong one, you may end up paying high fees and getting locked into a deal that doesn’t make sense for you.
But the right annuity can provide you with the security of knowing that you won’t outlive your money. And that’s something retirees crave, according to American College Dean and Chief Academic Officer Michael Finke.
“Most retirees will tell you that the money they’ve saved is for their own enjoyment. And yet when it comes to spending down their assets, it becomes a very complicated and scary process. They don’t know if they’re taking out too much or too little. Oftentimes, they’re overly cautious. Sometimes, they’re not cautious enough,” said Finke. “Our research1 shows they’re the happiest when the process is automated—when the money comes in in the form of a paycheck and they know that they can safely spend that amount of money every month, for life.”
In that respect, the predictable stream of income you get from an annuity is much like having a pension. And who wouldn’t want a paycheck for life? Still, while having steady income may help you feel happier and more financially confident in retirement, it’s important to purchase an annuity that is right for your circumstances. There are a lot of choices.
Here are five questions to ask before buying an annuity.
1. What do you want the annuity to do for you? If you’re already retired or planning to retire soon and want to create a steady stream of income right away, you can use a portion of your savings to purchase an immediate income annuity. You’ll start receiving payments immediately, and you’ll get a guaranteed stream of income every month for the rest of your life.
If you want to leverage your retirement savings and build up your future retirement income, a deferred income annuity might be a good choice. Plus, you don’t pay any taxes until the payments begin. “This can be a good choice for someone who’s 60 years old and who has made some gains in the market over the last eight years,” said Finke. “They can take some of those gains off the table now and buy a deferred income annuity that will start paying income in five or ten years.”
2. What are the riders and fees? Most financial products have fees associated with them so that the company selling the product or service can recover its cost of doing business, and annuities are no exception. But the fees will vary from one product to another and from one company to the next, so be sure to ask about them as you evaluate your annuity options. Beyond what might be considered standard fees, such as mortality and expense fees, you may also incur additional fees if you choose optional features—or riders, as they’re called. The feature(s) may be something you’re willing to pay for, but be clear about the added cost, and make sure you understand what you’re getting.
3. Can your monthly stream of income grow over time? Most annuities pay a fixed amount of income each month with little or no cost-of-living adjustment. Over time, that means you’ll lose purchasing power because the monthly payout won’t keep pace with inflation. You may be able to purchase an inflation protection feature (for an additional cost) that will raise your income by a certain percentage over time. Another option is to consider an income annuity that has the potential to grow through dividends.
4. Can you get your money back? One of the biggest misconceptions people have about buying an annuity is that once you purchase it, your money is locked in for life. That’s true for some annuities; it can be tough to get your money back if you change your mind or find yourself with an unexpected financial need. But annuities today are much more flexible and offer many more options than the annuities of the past. For example, when buying an annuity you can purchase a cash refund option that will pay any remaining portion of your initial contribution in one lump sum to your beneficiary when you die. Some annuities offer a one-time withdrawal option that allows you to take a certain amount out in case of an emergency. There is peace of mind knowing this is available. Keep in mind that if this option is used, there are costs involved, either up front or in the form of lower future payments.
5. What’s the credit quality of the company? When you purchase an annuity, you’ll be giving money to an insurance company in exchange for its promise to make payments to you each month for what could be a very long time. So you want to be sure you’re working with a company that’s strong and has a track record of making good financial decisions. One way to evaluate company quality is to look at its financial strength ratings, as awarded by the four major rating agencies.
When you take the time to thoroughly evaluate the options, you may feel more confident about considering the purchase of an annuity and more comfortable spending your money in retirement, according to Finke’s research.
“Our surveys show that when it comes to retirement income planning, safety is the number one thing that people care about,” he said. “Retirees want to know how much they’re going to be able to spend safely in retirement. They want clarity, and annuities can provide some of that clarity. But you have to do your research when it comes to understanding what kind of annuity product you’re buying.”
1Texas Tech Retirement Income Summary, 2016
Deferred Fixed Annuities are contracts sold by life insurance companies and are considered long-term investments that may be suitable for retirement.
Withdrawals from annuities may be subject to ordinary income tax, a 10% IRS early withdrawal penalty if taken before age 59½, and contractual withdrawal charges.
Dividends are not guaranteed.
All guarantees associated with annuities & income plans are backed solely by the claims-paying ability of the issuer.
Income annuities have no cash value. Typically, once issued, this annuity cannot be terminated (surrendered), and the premium paid for the annuity is not refundable and cannot be withdrawn.