Annuity - SafeMoney.com

annuities monopoly lifetime income

Unlike other types of vehicles, annuities are the only financial instrument capable of paying a guaranteed lifetime income. They are the only one on the planet. No individual investor can duplicate what insurance companies can offer you with paying you a guaranteed income stream.

Nor can any other asset class do what annuities do. They have contractual guarantees backing them.

Dollar-for-dollar capital reserve requirements, as well as mortality estimates built into every single payout by the insurance company, makes these income promises quite dependable. In this sense, annuities have a monopoly on lifetime income.

You can choose to receive guaranteed income for a certain timespan. Say you need guaranteed income for just 10 years. Then your guaranteed income can be structured to last for that long. Or you can receive guaranteed income for the rest of your life, regardless of how the markets perform.

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what does an annuity protect the contract owner against

Many people buy annuities for protection. But what kinds of protection can they provide? The answer depends in large part on the kind of annuity you own.

At the very least, all annuities can protect you against the financial risk of running out of money in retirement. Annuities counter this hazard by paying you a guaranteed income. Your income can last for a certain timespan or for life. This protection is available with fixed-type and variable annuities alike.

However, fixed annuities also protect the contract owner against downfalls tied to market risk, long-term care costs, and financial risks that can derail your legacy wishes. Here's a rundown of what an annuity can protect you against in your retirement-saving and post-retirement years.

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retirement annuity is retirement annuities right for you

In times of wild market swings and low-interest rates from Treasurys, CDs, and other fixed-interest assets, annuities can bring a sense of calm and predictability to a portfolio. Many people refer to annuities as "retirement annuities," because they are particularly well-designed for retirement goals.

Annuities are the only instrument capable of paying you a guaranteed income stream for as long as you live. No other instrument on the planet offers this.

You can think of this in terms of a monthly paycheck or money for life. You will receive a check in the mail from the life insurance company that you can count on, again and again, for the rest of your lifetime.

That is no matter how equity markets perform. Annuity income can therefore be seen as a kind of "private pension."

Speaking in an analogy, you already have your own annuity with Social Security payments. You paid into Social Security's coffers during your career. Then, when retired, you receive a monthly income that pays you like clockwork.

Annuities work in much the same way. They can be a great supplement to the assured income you will receive from your Social Security payouts.

Depending upon your overall goals, annuities can also help you reach your objectives with other contract features as well. Here's a look at why retirement annuities can bring predictability to your lifestyle and stability to your portfolio.

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how do annuities give market protection

Sometimes the stock market can go through a rough patch. The market takes a dive, and then the near-term outlook for stocks might not be that rosy. During those times, many people go on the hunt for ways to keep their money safe.

For millions of Americans, one answer is fixed-type annuities. If you are considering annuities as a place of refuge, then this next question couldn’t be more important for you.

If you had money in a fixed annuity or a fixed index annuity and the market dropped, how much money would you lose? The answer, of course, is not even a cent due to the market falling.

One of the benefits of fixed and index annuities is their guarantee of principal protection. When you put money into a fixed index annuity, the insurance company pledges to keep your money protected from falling index values. The financial safety nets that it maintains to protect your money are indeed very strong.

Even if the market sees a swing like it did in the early 2000s or in 2008, it wouldn't matter. Your money will stay intact inside your annuity contract.

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who guarantees annuities

People buy annuities for many reasons, from market protection to guaranteed income payouts. After all, an annuity is the only instrument capable of paying a guaranteed income for life. But who guarantees annuities? What sort of safeguards stand behind those guarantees?

The annuity guarantor is, of course, the life insurance company issuing the contract.

By law, life insurance companies must maintain very strict capital reserves for every dollar of fixed annuity premium. State regulators require annuity insurers to keep dollar-for-dollar reserves in coverage for every dollar of fixed annuity premium they hold.

Many life insurance companies hold reserves above this. For example, some insurers have $1.08 in reserve capital for every annuity premium dollar.

Hence, this is what financial pundits mean when they say that a life insurer's ability to make good on their annuity promises depend on that company's financial strength and claims-paying ability.

What about other safeguards if an insurance company has a liquidity problem? There are also other measures that state insurance regulators put in place as a financial safety net.

Let's get more into the details of how insurance companies' financial strength are monitored. We will also cover some of these other safety net features that help back up fixed annuity guarantees to policyholders.

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what are the risks with annuities in a recession

Annuities have become increasingly popular in recent years. While due to many reasons, two big ones are that annuities pay guaranteed income and provide tax-advantaged growth for your money.

The biggest advantage of their guaranteed payouts? Your income stream doesn't change with political or economic conditions, such as a recession.

The technical definition of an economic recession is two successive quarters of negative economic growth. The National Bureau of Economic Research (NBER) is the body that determines when the U.S. economy is going through a recessionary period.

According to research by NBER and graph data from the Federal Reserve Bank of St. Louis, the United States has been through 17 recessions since 1920.

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Annuities come in all sorts of flavors, but the two primary flavors are fixed annuities and variable annuities. One type of fixed annuity, the fixed index annuity, is so popular with retirees and working-age retirement savers, it’s also worth a mention.

The biggest risk with annuities in a recession is risk of loss – or how much the money you have parked in the annuity loses value due to market conditions. Depending on the type of annuity you hold, your money might be at greater risk for loss based on how the market behaves.

Let’s go into more depth about these annuity types and how a recession affects them differently.

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annuity prices what you need to know

How is an annuity priced? And why should it matter to you? While you may be exploring an annuity for your retirement, many Americans count on fixed annuity contracts as a safeguard against today’s economic uncertainty.

In many ways, retirees and retirement savers have had a rough go in this ever-changing economic climate. Retired Americans have sought to find choices that pay sufficient regular income for their monthly household needs. Risk-averse savers also have been hit particularly hard, as interest rates still remain near historic lows.

Millions of people have found peace of mind by receiving a lifetime income stream from an annuity contract. This type of payout will guarantee someone a fixed sum of money on a regular basis for as long as he or she lives.

But how can you, the annuitant on the contract, know if you are getting a good deal on the annuity (a fair annuity price) when you buy one for your portfolio? There are several factors that enter into how a life insurance company will price its annuity payouts.

To help you receive the best “bang for your buck,” it’s good to understand how these factors can affect the pricing of annuities by insurance companies -- and the impact on the annuity payout you will receive.

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is an annuity a liquid asset

Annuities can provide retirement savers with many unique benefits: tax-deferred growth, guaranteed lifetime income, guaranteed interest rates, and protection from downside risk, to name a few.

For the most part, the IRS doesn’t have limits on how much money can be placed inside an annuity, giving people more opportunity to take advantage of the contractual guarantees. And if you want more growth potential for your money, fixed annuities and fixed index annuities can earn higher interest while protecting your principal.

However, one limitation that annuities have is their liquidity. Annuity owners give up having complete liquidity in exchange for these benefits, and if their money is in fixed-type annuity contracts, that is a very safe place with the dollar-for-dollar reserves that insurance companies must maintain.

So, are annuities a liquid asset? Yes, they offer some liquidity, but not as much liquidity as you might find in other types of assets in today’s markets. It’s a trade-off for those rock-solid, guaranteed benefits that they provide.

Even so, there are some provisions for liquidity in annuity contracts. You might access your money in a variety of ways: free withdrawals, cumulative free withdrawals, and waivers of surrender charges (where you get your money back in a qualifying situation) are a few.

Let’s talk about the liquidity of annuities in more detail.

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what is an annuity free withdrawal

One of the chief criticisms of annuities is their relative lack of liquidity. This is true in some respects. Annuity owners give up complete liquidity in exchange for other benefits, including insurer guarantees for lifetime income, guaranteed growth, or protection from downside risk.

Many annuities now come with guaranteed income riders that can be turned off and on while letting you still access at least some principal. And most contracts do offer something called "free withdrawals."

What is a Free Withdrawal?

A free withdrawal is a payment you can take out of your annuity without having to pay a penalty, or a surrender charge, as the insurance company calls it. In most cases this free withdrawal amount will be equal to a given percentage of your annuity's accumulation value each year, such as 5% or 10%.

If you withdraw more than this amount in a given year, then you will have to pay a back-end surrender charge on the excess amount.

So, say your contract allows you to withdraw 5% per year and you withdraw 7%. Then you will have to pay a surrender charge on the excess 2%.

Of course, you will generally have to pay taxes on the amount you withdraw. Since annuities are intended as retirement savings vehicles, you might also face a 10% early withdrawal penalty on any money you take out before age 59.5.  

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annuities tax efficient retirement strategies

As an annuity owner, you take comfort in knowing that you have planned for an uninterrupted lifelong retirement income stream. Working alongside other income sources from your nest egg, it will pay out, like clockwork, to fund the retirement you have always imagined.

But have you considered whether your income streams are as "efficient" as possible? Whatever retirement strategy you choose — income and all — needs to be "tax-efficient" to ensure you get the most mileage out of your money.

This is just one more piece in the retirement planning puzzle that each of us must solve. When we don't plan for retirement, we run the risk of underspending or overspending our retirement dollars.

What if underspending doesn’t seem like a problem, but rather like an advantage? Consider what events and opportunities to which you may say “no.” And simply because underspending pressures you to have a scarcity mentality, or when you don’t really know if you can afford them.

Perhaps you might pass on an important family event or skip that overseas vacation you always expected to be a highlight of your retirement years. All because you didn’t have a true picture of your anticipated income compared to your expenses.

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annuity myths image

Before you add an annuity to your income strategy, it’s prudent to understand what an annuity does and what it doesn’t do.

Essentially, annuities are insurance contracts. They are built to pay lifelong streams of fixed income, protect money from market losses, or offer tax-deferred money growth.

Indeed, billions of dollars sit in these contracts. A large part of that is due to their popularity for lifetime income, or for higher growth potential than with other low-risk interest-earning vehicles.

Nonetheless, there are still a number of myths and misconceptions about annuities. That might be attributable to a few factors, from annuities being fairly complex to misleading annuity marketing and sales tactics being touted.

This isn’t to say that annuities don’t have a place in a retirement portfolio.

Just like with any other financial vehicle, though, they must have a specified role. That can include solving for particular retirement risks, working in tandem with other parts of a portfolio to reach certain goals, or even simply providing peace of mind with predictable retirement income streams.

Let’s break down some annuity myths and misunderstandings, one-by-one, and learn more about them.

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should you buy an annuity when interest rates are low

If you are approaching retirement, chances are you have been started exploring how you might enjoy a financially confident retired lifestyle.

This includes maximizing the value of your retirement portfolio – and creating dependable income streams that last as long as you need them to.

For retirement investors, one way to solve for this concern is drawing on a lifetime income stream from an annuity. But how appealing are annuities in the face of historically low interest rates? Especially ones such as those we have experienced for the last several years?

Since 2009, in the aftermath of the Great Recession, most developed countries have experienced a low-interest rate environment. Monetary authorities have sought to use low-interest rate schemas in order to spur economic growth and prevent deflation.

The U.S. saw rates cut to effectively 0% until 2016, when they began to inch higher. Still, today, the federal funds rate is only 2.5%, up just half-a-point from this time last year when it measured 2%.

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annuity inflation risk img

“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man,” Ronald Reagan once famously said.

And the worst time to try to fight this formidable foe is when you are in retirement, living on a fixed income. Many people have some employment, or some involvement with entrepreneurship, for a stream of retirement income.

But chances are they don't offer wage increases, or other inflation-countering benefits that you might have had in your working years, to help you keep pace.

Annuities are one of the few ways to obtain retirement income that is paid out as long as you live, making them a popular component of many retirement plans.

Investors have been using fixed annuities and fixed index annuities to provide lifetime income. These guaranteed income streams cover monthly costs and help people maintain their standard of living.

But if the annuity payout is fixed at the outset of the contract, by design it can’t be increased to keep pace with inflation. Should inflation rise 10% over time, for example, the buying power of a $3,300 monthly annuity payout erodes to $2,970.

This threat has the potential to affect a retiree’s lifestyle and could even require making unwelcome cuts in spending.

So how can investors seeking the benefits of annuities manage this inherent “inflation risk” and offset its impact? These are just a few of the ways.

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market value adjustment how it works

Have annuities ever popped up on your retirement-planning radar? You might have come across some annuity contracts with a Market Value Adjustment feature. Several fixed index annuities and multi-year guarantee annuities (MYGAs) include this factor in their contracts.

A market value adjustment (MVA) simply refers to the ability of an insurance carrier to offer you higher rates by protecting itself against bond market declines. When an annuity has a market value adjustment in its contract, it’s called a market value adjusted annuity (or MVA annuity for short).

Normally the insurance company holds the interest-rate risk when you buy a fixed annuity. But an MVA annuity gives you the chance to earn a higher rate in exchange for sharing in some of that risk with your insurer.

After all, bond values are sensitive to interest rate movements. So one way to think of this is as a “safeguard” for the insurance carrier against bond market losses.  

If an MVA annuity happens to fall into your retirement purview, here’s a helpful look at what it might involve.

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how annuity indexing works

Annuities come in all shapes and sizes. And when you are considering one as part of your retirement strategy, sure, it’s important to determine whether an annuity is right for your financial situation.

But there are more annuities than hedge funds in today’s financial marketplace. That is a staggering number of options. If, relative to other solutions, an annuity does help you achieve your retirement goals, then choosing the right one is just as important as its role in your portfolio.

When people plan for their retirement, they usually have one chance to get it right. Your choices will determine whether you live well in later years – or will fall short and will have to deal with the results. This applies just as much to annuity purchase decisions as well as other financial choices for your future.

If you happen to be considering a fixed index annuity for your retirement, understanding how the annuity indexing works is a crucial component.

Your index annuity has many ways of being credited interest. And you might also have a wide menu of index options, from the plain-vanilla S&P 500 price index to newly-minted “volatility controlled” indices.  

First, let’s explore how annuity indexing works. This will cover only annuities of the fixed variety.

Then we will address the new wave of indexing options that include volatility controls, which are a debated topic in the industry.

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annuity mistakes avoid

Whether you are considering purchasing an annuity or you already have one, there are some key mistakes to avoid in order to benefit from annuity ownership.

The pitfalls below have tripped up many annuity buyers. Our insider tips on knowing what to look out for can prevent you from experiencing the same fate. Use these tips to help you in simplifying your annuity buying decisions or in optimizing your annuity contract as part of your retirement strategy.

Mistake #1: Thinking you can get out of an annuity at any time.

Insurance companies stipulate “surrender” periods in an annuity contract for a reason. They want you to hold the contract for at least that length of time.

These surrender periods are part of annuity contracts for many reasons. One of the most important is it helps the insurance company maintain the guarantees it’s promised to you as a policyholder.

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fixed annuity reach near record sales

Rising interest rates and an easing regulatory environment are contributing to near-record levels of fixed annuity sales. It’s good news for people who might rely on these fixed contracts for guaranteed income or protection. A strong marketplace can lend to new innovations, contract benefits, and contract features.

In the second quarter of 2018, total fixed annuity sales reached $33.7 billion, an 18% increase over second quarter 2017 sales. That figure shattered the quarterly benchmark, according to the LIMRA Secure Retirement Institute (LIMRA), a financial industry research firm.

Year-to-date, total fixed annuity sales were $60.9 billion, 9% higher than the first half of 2017, LIMRA reported.

Why all the excitement and elevated interest in fixed annuities? Two possible reasons - rising interest rates and relaxing regulatory pressures on financial markets.

"These products offer a unique value for retirees and pre-retirees seeking protected accumulation and guaranteed lifetime income features," says Todd Giesing, LIMRA’s annuity research director, in an interview with InvestmentNews. "Clearly, with the Department of Labor’s (DOL) fiduciary rule vacated and the prospect of continued rising interest rates, demand for this product is high."

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ken fisher annuities intro img

Photo Credit: Fisher Investments, Featured in USA Today Special, Source Link. Photo is strictly intellectual property of its owner. All Rights Reserved. 

Long-time money manager Ken Fisher says he hates annuities. And he isn’t exactly shy about it. Since 2013, the head of Fisher Investments has run many blistering anti-annuity promotions – from critical columns and print ads to aggressive TV spots and online display advertising.

Over time, those promotional spots have driven market awareness, boosting Fisher's profile as a well-recognized annuity critic. Many campaigns still run today, with the ads building on the Fisher celebrity, retirement tips, annuity leg sweeps, or other stickler points.

But while the annuity marketing blitz has been a success, a recent article raises questions about Fisher’s strong public stand against annuities.

It may point to what some call a contradiction between the “I hate annuities” mantra of Fisher advertising campaigns and the investment holdings of Fisher’s firm.

At InvestmentNews, reporter Greg Iacurci writes that while the infamous anti-annuity ads were running, Fisher Investments itself was invested in companies with large annuity business.

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annuity myths 1 pic

Before you commit to an annuity as part of your retirement plan, it’s good to know the basics of this retirement tool. Every year, Americans put hundreds of millions of dollars into new annuity policies. Yet there still seems to be a measure of annuity misconceptions and confusion among consumers.  

You may have seen that a quick internet search of the word "annuity" delivers a wildly diverse set of opinions! And every financial pundit has their own take on annuities. Some of the loudest voices on the internet even claim to be against them, all the while offering annuity or annuity-like solutions to their following.

To help you sort through the noise, we break down common annuity myths and supplement the conversation with some facts.

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how safe are annuities

Once a retirement staple, pensions have been gradually disappearing. Now we hold more responsibility for retirement than ever. That has its own challenges, including how to overcome longevity risk. You have to figure out how to pay for potentially decades of retired living.

Arguably one of the best ways to combat longevity risk is with annuities. However, as you come into the home-stretch and explore your income options, it’s natural to ask, “How safe are annuities for my retirement?”

The good news is they can be quite safe. But there will be some legwork involved to make any annuity-buying decisions that are right for you. Here are some pointers to follow as you consider an annuity for your retirement portfolio.

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annuities in employer retirement plans

The American workplace has seen remarkable advancements over the past 20 years. From technology that has revolutionized the way we work, to the physical environments we work in, to the changing workplace conditions, almost every facet of the American workplace has been modernized. Every facet, it turns out, except, perhaps, the workplace retirement plan.

But American workers may soon benefit from new options within their retirement plans, thanks to several bipartisan bills. The pieces of legislation are currently under review by a congressional subcommittee, and they are designed to update the Employee Retirement Income Security Act (ERISA).

"Many ERISA provisions related to retirement plan administration are in desperate need of updating, with some having last been revised over two decades ago," according to Rep. Tim Walberg, chairman of the Subcommittee on Health, Employment, Labor and Pensions.

Walberg voiced this opinion during a recent hearing on "Enhancing Retirement Security: Examining Proposals to Simplify and Modernize Retirement Plan Administration."

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are annuities taxable

Are annuities taxable? It's an important question if you are shopping for annuities with the goal of guaranteed income. An annuity can help us sleep better at night, knowing how much income the contract will provide each month and that it can last as long as we do.

But while guaranteed income may sound good, there is also the flip-side to consider. You may wonder about whether annuity contracts might pose a potential tax trap.

It's smart to consider the topic. And why? Because taxes are a primary concern for people in retirement. While released in 2010, a survey by Lincoln Financial Group still has relevance today. 

The study of affluent retirees found that federal income taxes were their largest expense. Among the respondents—age 62 through 75 with annual household incomes greater than $100,000—taxes were their largest expense. The survey results show that nearly 1 of every 3 dollars a retiree spent went to taxes.

Good news, though. A 2016 article by the Center for Retirement Research suggests that a "tax time bomb" may not be inevitable for many retirees. However, that premise is based upon 2007 U.S. household taxpayer numbers crunched by the Hamilton Project.

And other research, like a 2014 study on middle-income household awareness of retirement tax issues by Bankers Life, shows that taxes could well be a considerable chunk of future retiree spending. 

All of which leads back to that question: How could throwing annuities into the mix affect a tax bill?

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market value adjustment

Have you heard of a “market value adjustment” when researching annuities? A market value adjustment is a contract feature that comes with annuities of the fixed variety. Generally you will find it attached to traditional fixed annuities and indexed annuities.

A contract with this feature is called a “market value adjusted annuity,” or an MVA annuity for short. MVA annuities tend to offer higher interest rates than regular fixed annuities do.

With a market value adjustment feature in the contract, the insurance company shares some of its investment risk with an annuity policyholder. In exchange, the policyholder may enjoy more chances for growth potential than a regular fixed contract may provide. That being said, the market value adjustment factor applies typically to excess contract withdrawals and surrender charges. And depending on the interest rate environment, an MVA may be positive or negative, which can increase or decrease a surrender charge amount. 

The insurance company uses the market value adjustment factor as a safeguard against annuity contract surrenders and, in turn, to maintain its financial strength. That way it can maintain its contractual guarantees and promises made to its annuity policyholders.

Let's look more at what a market value adjustment involves -- and how it may be beneficial or negative.

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annuity beneficiary payout options

You may have invested a fair amount of time crafting your retirement plan. Your financial plan might include an annuity that could both maximize your lifetime income and maximize the potential payout to your chosen beneficiaries. But you may not have focused on the options that your beneficiaries have when choosing how to take their payout.

So, what are the annuity beneficiary payout options and how do they work? Let’s find out.

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indexed annuity floor

Some index-based financial products have a "floor," or the maximum value you would lose if the index went down. In a fixed indexed annuity, the floor is expressed as a guaranteed minimum interest rate. This floor is usually set at at an annual rate of 0%, meaning that even if the index decreases in value, the interest to be credited won't be negative.

Essentially, the annuity floor will consist of your annuity's accumulation value plus the guaranteed minimum rate. You can never lose money due to any index declines. But your money may lose value in the times of index losses, if the indexed annuity contract has optional rider fees or you pay a surrender charge for early withdrawals.

If you are researching fixed index annuities to see if annuities may be for you, it's helpful to have a good knowledge of the essentials. Let's get started with a more in-depth discussion of a fixed indexed annuity, some of its common features, and how the floor guarantee may work.

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