Annuities raise many questions for people. They are a
powerful financial tool that can only be offered by someone who has a license to
sell insurance. This is because Annuities are an insurance policy.
The purpose of the policy is to guarantee that you will not outlive your
income. Annuities are designed to pay a consistent income stream to
you for retirement after a period of investment growth. This can be
used to supplement your Social Security income, pension, etc.
One of the things that attracts many people to annuities is
that they like the deferred tax compounding offered by an annuity.
Some people never elect to take an income. They see it simply as a
good investment with the flexibility to take lump sums of money out over
time.
Others see annuities as an estate planning tool that
avoids probate and can easily be transferred to their heirs. Some
annuities can be assumed by the beneficiaries, thereby continuing to defer
the tax liability for generations. This is called Multi-generational
planning -- it is powerful! Multi-generational planning takes
advantage of something called Required Minimum Distributions for IRAs, 401Ks
and other qualified retirement savings plans.
There are three basic types of annuities:
1. Fixed Interest Annuities: These annuities
have very low risk. The insurance company guarantees a minimum fixed
interest rate, and your investment grows at that rate or higher (if the
company declares a high interest rate in the future) for the life on the
contract. The biggest risk in this case is the financial viability and
ratings of the company offering the annuity. Otherwise, they are like
a tax-deferred bank CD.
2. Variable Annuities: These annuities have a
higher risk because your investment is placed directly into mutual funds --
which can rise or fall in value. You may earn 30% in one year, but you
may lose 30 in another. For many people, this risk is too much after
watching their other investments in the stock market plummet in the past few
years.
3. Equity-Indexed Annuities: These annuities
are medium risk, where you cannot lose your principle investment, but you
have little assurance of gains over the life of the contract. Equity
index annuities track the performance of a major index, such as the S&P-500
or the Nasdaq-100. If the S&P-500 gains 10%, your account gains 10%.
Be careful though - many times, companies have fees, spreads and caps that
will dramatically reduce the performance of your investment.
Most companies offer annuities that are combination
of the EIA and the FIA above -- you are guaranteed a fixed about (such as
3%) plus the upside of the stock market up to a cap. This cap can be
anywhere from 8% - 15%.
Annuities are not for everyone. In fact, most people that own an
annuity don't really understand its advantage over a managed portfolio of
mutual funds or bank CDs. If you are interested in annuities, make
sure that you get educated. Rather than reinvent the wheel, here are
some links that we recommend:
American Equity Annuity Tutorial:
http://www.american-equity.com/tools/default.asp
American Savings Education Council
http://www.asec.org/terms.htm
If you think Annuities might be right for you, give us a
call, we'll make sure that you completely understand what you are getting
into.
