Investment Engines Inside Annuities
If you’re like me and don’t have a pension from your workplace, you should learn about the different investment engines inside annuities.
The type of annuity that most people think of when they hear the word “annuity”, is an immediate annuity. This is when you give your money to an insurance company. In turn, they provide a set payment to you. There are options available on how long payments will last. You can also set up a payment plan for both your life and the life of your spouse.
You can choose to define the period of time the annuity will pay, from 10 years up to your entire life. The downside is that you lose control over the money you invested in return for the income. Some folks don’t like having an illiquid asset, which is typically what an annuity is, at least for the short term. Other types of annuities are more established tax-deferred investments. They just have different types of investment “engines” inside. The trick is to identify the type that best meets your needs.
A fixed annuity is similar to a CD because interest is guaranteed for a period of time. Earnings are compounded daily from interest, and this rate may be high or low, depending on what current rates were at the time the annuity was purchased. Obviously, it is preferable to be locked in with a higher rate. However, you aren’t invested in the markets. In other words, you don’t see fluctuations to the downside in these accounts. You can also annuitize (“turn on” the payments).
A variable annuity is very similar to the fixed, but has a mutual fund-like investment as its engine. Managing these sub-accounts are the same quality managers who run mutual funds. Likewise, you typically pay a fee for their management of your funds.
Also, insurance companies typically charge a fee called mortality and expense. This is a way for the company to create revenue for themselves. If you add extra features (riders) to your annuity, those riders usually have a cost associated with them.
Because variable annuities have market-based investments at their core, you see the value of the contract fluctuate as stock markets fluctuate. If you purchase an income rider, you can create a guaranteed income stream from that annuity. You can also pass any remaining value to loved ones. Another rider can provide a death benefit for your heirs, which would not be subject to the market’s potential losses. Just remember that every rider has a cost related to its guarantees.
Fixed-Index Annuity (FIA)
A fixed-index annuity (FIA) has characteristics of both the fixed and variable annuities. FIAs are similar to fixed annuities in that you don’t experience market losses. Your investment participates in positive returns but doesn’t experience losses when markets are in decline. The word participate is important because FIAs use interest credit to purchase an option on a market index. This means you won’t capture all market returns when it is positive. Simply stated, it’s a trade-off for not having the potential for loss.
An income rider provides lifetime income. If there is money remaining in the contract, it passes to your beneficiaries. However, an income rider allows the annuity to keep paying income, even after the paid-in amount is depleted.
Know Your Investment Engines
As you see, not all annuities are the same, and riders can add a whole new dimension to them. If you’re considering an annuity, work with an experienced Advisor. Your Advisor should illustrate various benefits and options provided by the different investment engines inside annuities. They should also clearly explain all costs associated with an annuity including tax implications, fees, and liquidity.
An annuity is a tool that performs a specific function. To work properly, you need to select the one that best meets your needs. Should you have any questions, or like a second opinion, just let me know. One of the Advisors here at Maestro Wealth, will be happy to help.