Laurel Insurance Services

Lets talk about the 4 types of annuities.

There are multiple reasons why a lot of advisors want to avoid recommending an annuity to a client, despite the litany of information that they can be a great solution and valuable asset to many client’s portfolio if used correctly.

Advisors might not bring them to the table when developing a financial plan because annuities can often convoluted, making it hard for even an advisor to understand and consequently for the client to grasp.  Because of this they can appear to lack transparency.  Another reason is the advisor is not paid trails (or compensation from fees charged each year).

First, annuities are not for everyone, just as some mutual funds or other investments are not for everyone, but they do have their place.  If you are looking for a flight to safety,  guaranteed income and potential (certainty rather) to earn greater interest than a fixed interest vehicle, annuities may be a good option.

Second, just as Life insurance is  protection for dying to young, an Annuity is protection for living too long!

Let’s take a look at the basic types:  

1) Single Premium Immediate Annuities (SPIA).  When people think “annuity”, this is what they think of.  You put a lump sum of money with an insurance carrier, they guarantee you income for life.  The advantage is obviously you cannot out live your money.  The disadvantage is that you give up your liquidity; your money now belongs to the insurance company.  However, these can work especially well for those with tight budgets or small retirement plans.  This annuity is the easiest type to understand.

2) Deferred Income Annuity: Much like a SPIA, this is a single premium insurance product that focuses on guaranteed income that you cannot outlive.  The only difference is that income payments are deferred, or income starts at a later date.  These are great for those retirees that have enough money to get them through at least a specific number of years, but still have doubts about outliving their retirement.  Because payments begin at a later date, you get more for your dollar.  Since income begins later, they have your money for longer before starting to payout, therefore income payments are higher.  One important factor to consider when looking into this type of annuity for your financial plan is purchasing power risk.  If the cost of living or inflation is greater than the interest earned on the annuity you will have less value for your dollar at the time income begins.

3) Fixed Indexed Annuity:  Also known as Fixed Equity Indexed Annuity (FEIA) are the lastest annuity to be added to the annuity aresenal.  The main objective is growth with market loss avoidance.  These can be the most confusing annuity to understand.  For simplicity sake, principal is guaranteed while you still have the upside of market returns (to a certain degree).  For example if the annuity is linked to the S&P 500 and the indices experiences a 15% return at the annuities anniversary date, and the participation rate is of the annuity is 70%, you only receive 70% of the market’s return.  15% x 70%= 10.50% would be credited to the annuity value.  Conversely if the market falls 15%, the annuity’s value is protected against loss.  (See previous BLOG post on Sequence of Returns)

4) Variable Annuity: Variable annuities can have a fair amount of risk, depending on how clients’ money is allocated to the market.  The subacounts in the underlying annuity can have investments ranging from very conservative to very high risk.  This annuity is still subject to the ebbs and flows of the market.  However, despite the market risk, these annuities can provide a guaranteed lifetime income that could potentially increases  (with an added cost/internal charge) .  These can be a great alternative for the investor looking to minimize tax liablity because all annuities are tax-deferred.  These are great for investors who have already maxed out other retirement accounts (Roth IRA, Traditional IRA, 401K, SEP IRA).  So for the investor looking for greater growth potetial with the tax benefits annuities offer, variable annuities can be a great option!  The disadvantage is the fees or cost.  Some fees tend to exorbitant therefore lowering the actual growth over time.