Millions of Americans depend on annuities for retirement and for tax-advantaged accumulation. But if you are considering one, you might be unsure about which questions to ask about an annuity. Beyond that, you also want to be able to judge whether a specific annuity product is right for you.
Essentially, an annuity is a contract between you and a life insurance company. The contract provides tax-deferred growth for your money and different choices for your payout options: a lump-sum payment, income for life, or income for a set period.
Most annuities are started with money from retirement accounts — 401(k) plans, IRAs, or Roth accounts. But you can also purchase an annuity with personal savings or proceeds from a transaction like a home sale. The money you use to begin your annuity contract will have its own tax implications, so keep that in mind as you consider your options.
Determining what annuity is right for you is up there with other important retirement decisions. After all, these are your life savings.
You want to be sure that you bought the right annuity contract — if indeed it does make sense for you — and that its unique features and benefits solve for the existing gaps in your portfolio.
Here are some questions to ask about annuity options that can help you narrow down your choices to the right fit.
15 Questions to Ask About an Annuity
Ask these questions to determine what sort of annuity might work best in your favor:
- What do I want my annuity to do?
- When do I plan on using the money I paid into the annuity?
- What guarantees are offered with the annuity?
- What is my risk tolerance and how much risk do I already hold?
- How much liquidity does the annuity offer me?
- What proportion of my assets and savings are appropriate for an annuity?
- Why is my agent or advisor making this recommendation?
- Are there any add-on benefits to this annuity? How much do they cost?
- What are all of the fees and charges I will pay in this annuity?
- If my goal is income, at what age can I start my annuity payments?
- How financially sound is the insurer that would issue this annuity?
- What would happen to my money if the market went up, went down, or stayed flat?
- If this is a fixed or indexed annuity, what is the guaranteed minimum interest rate?
- What are the pros, cons, and other potential mishaps with this annuity?
- Does my financial advisor or agent give me confidence?
You can use these questions as overall guiding tools or as steering points in your conversations with your financial professional about different annuity options. Here they are, one by one:
1. What Do I Want My Annuity to Do?
Your annuity should serve a specific purpose. Would you use it to save for retirement? To pay you guaranteed income?
To protect your money from market losses? Or maybe it might do a combination of these.
This is probably the most important question that you can ask about a specific annuity product. If you are looking for guaranteed income, then you may want a different annuity product than if you were seeking moreso long-term growth.
But all fixed and fixed index annuities will protect you from market losses. So, if that is your primary objective, then you can survey a wider group of annuity products.
2. When Do I Plan on Using the Money I Paid into the Annuity?
What is your timeline for this money? How long will your particular financial goal with your annuity need to be covered for? As mentioned, many annuity owners have goals of income, growth, or even both.
If you are just looking to take required minimum distributions (RMDs), then a wide array of annuity products will fit the bill.
But what if you want greater freedom with how you take your distributions? Then you can shop around to find out which contracts can provide you with the distribution options that work for you.
3. What Guarantees Are Offered with the Annuity?
What are the specifics of those annuity guarantees? Are there any situations where the guarantees wouldn’t apply? Any situations where they might even become inactive? If so, what are they?
All fixed annuities will guarantee both the interest and the principal that is paid from the contract. Indexed annuities will guarantee your principal, but the interest earnings aren’t. How much interest that your money earns will depend on the movements of your indexed annuity’s underlying benchmark.
And if you annuitize the contract, then you are guaranteed income for life, or at least for a certain period of time.
If you want more flexibility, you can also receive guaranteed payments by tapping an income rider benefit with your annuity. Keep in mind that the rider benefit may or not come at additional cost, which is covered more below.
Unless the insurance company goes under, there are no situations where these guarantees wouldn’t apply. Even then, certain safeguards would kick in to continue your guaranteed income payments.
Even so, life insurance companies have a strong historical record as annuity guarantors.
4. What Is My Risk Tolerance and How Much Risk Do I Already Hold in My Portfolio?
Is a variable annuity, a fixed-rate annuity, or an indexed annuity right for you? The answer to this will depend upon how much of your current portfolio is invested in the markets. Different assets have different investment risks.
If your primary holdings are in CDs and other guaranteed instruments, then an indexed or variable annuity may be the right choice for you. Indexed annuities are designed to grow more in value over time than fixed annuities or CDs.
A variable annuity’s value will rise and fall in tandem with the performance of the variable annuity’s underlying mutual fund subaccounts. As a result, variable annuities have risk of loss due to market declines. But in exchange for loss risk, they also have the most growth potential of all annuities.
That being said, if you are looking for guaranteed interest and principal, then a fixed annuity may be a good choice for you.
5. How Much Liquidity Does the Annuity Offer Me?
Most annuity contracts have surrender charges, or penalties for taking out too much money during the contract maturity period. Here are some points to think about.
What are the surrender charges, or excessive withdrawal charges, if you take too much money out of the contract too early? How long does the surrender period, or the timeline for contract maturity, last for?
Most annuities will allow you to take 5 or 10 percent of the initial contract value out of the annuity each year without penalty. This ability is called an annuity free withdrawal. But the surrender charge period can last as long as 15 years for some contracts.
However, this isn’t the norm for the vast majority of annuity contracts and applies to only a few, but it gives an idea of how long a contract commitment might run.
New contracts coming into the annuity market have mucher shorter surrender periods than 15 years. That is why it’s advantageous to see the options available to you. It lets you weigh different commitments with various options on your end.
Annuities aren’t designed to be the most liquid of instruments. If you think that you will need to take out all of your principal in a year or two, then an annuity probably isn’t right for you.
That being said, you can take a partial withdrawal of money out, without any surrender charges, for emergency situations. Those situations include for terminal illness, confinement in a nursing home, or even death.
Some contracts will provide more liquidity for these situations, so check your annuity contract for details in that case.
6. What Proportion of My Assets and Savings Are Appropriate for an Annuity?
How much money should you put into an annuity, and why? What makes sense for your personal financial goals?
Most annuity companies will require extra documentation if you are putting over half of your liquid net-worth into an annuity contract. They want to see that this is in your best financial interest.
It’s important to have some money liquid in a cash account, such as a money market fund. If something unexpected comes up, you can access this liquidity immediately if you need to.
Generally it’s not wise to tie up all of your money in annuities. Why? Because you may have to pay surrender charges if you need to access more than a certain percentage of your principal.
7. Why Are You, the Advisor, Making This Specific Recommendation for My Annuity Options?
If you are looking for a guarantee of principal with higher rates, then an indexed annuity is probably the right call for you.
Should you feel comfortable risking your money in the markets in order to get a higher rate of growth over time, then a variable annuity might meet your expectations. If you are looking for guaranteed rate of interest, then a fixed annuity can be appropriate.
8. Are There Any Add-On Benefits to This Annuity Contract?
This is a good question to consider with your advisor or insurance professional. How much do these add-ons cost, in a simple explanation?
Do any of the add-on benefits make sense for you? If so, why?
Most annuity contracts today come with an assortment of guarantees and benefits that may or may not come at an additional cost. Liquidity features such as for death, disability, or terminal illness are usually built into the contract.
Guaranteed income riders usually cost around one percent per year. It’s prudent to carefully review the optional benefits that your contract offers in order to know how much they will cost and what they will guarantee.
9. What Are All of the Fees and Charges That I Will Pay in This Annuity?
There is no such thing as a free lunch in economics. Different annuity come with various fee and charge structures. Some annuities come with little to no fees, whereas others can be fairly cost-involved.
One way to sort through your options is to ask these questions: In one year, how much do all of the fees add up to?
If costs are built into your annuity contract, how does it affect the growth potential of your money? As those benefits are part of the contract design, you aren’t paying for them, and so the life insurer will limit some of your annuity’s growth potential in exchange for these additional guarantees it’s providing.
What other charges, if any, may be deducted from your contract or your annuity premium payment?
The answers to these questions will vary from one carrier and product to another. The provisions of your specific annuity contract will spell out exactly what you will pay for a given optional feature or benefit. Your financial professional can cover this with you.
If you are purchasing an indexed or variable annuity, then any optional riders or benefits will likely come at an additional cost. Living and death benefits may be built into the contract. Be sure to ask your financial professional about what they might involve or cost.
In some contracts with these benefits, there may be a base amount of fees that you have to pay each year regardless of whether you choose to use any additional benefits.
You usually find this sort of fee schedule in variable annuities. These fees will be clearly listed in the variable annuity prospectus.
10. If My Goal Is Income, At What Age Can I Start My Income Payments?
Sometimes annuities require you to ‘wait’ before you can begin your guaranteed payouts from them. If you are evaluating a specific annuity, ask if there is a waiting period, where you would have to wait a certain amount of years into the contract, before you could start receiving payouts.
Under federal tax law, you can start to receive income from your annuity at age 59.5, if you like. Any distributions that you take before this age will be subject to the 10% early withdrawal penalty by the IRS. Your withdrawals will also be taxable as ordinary income.
In many cases, you may be able to start taking income from your annuity in the first year of the contract, depending on the terms of the contract. You would just have to take an amount that falls below the penalty-free withdrawal limit during the surrender charge period.
11. How Financially Sound is the Insurer That Would Issue This Annuity?
Ask your financial advisor or agent why they are recommending this insurance company for your annuity.
Life insurance companies are rated just like bonds. The safest insurers are rated with a AAA or A++ rating, while lesser insurers are given a lower rating. But any insurer with an A rating or better is probably a safe bet.
And don’t just write off companies with a mid-grade B-rating, either. Even those may be good candidates because they offer greater payouts or free benefits to offset their greater risk of default. But historically this hasn’t happened often.
Again, life insurance companies have a strong record in economic history of upholding their promises.
12. What Would Happen to My Money if the Market Went Up, Went Down, or Stayed Flat?
Imagine that you put $200,000 into an annuity today. Then the market went up, went down, or stayed flat next year. What would happen to the contract value of the annuity you had bought?
The answer to that will depend on the type of annuity that you bought. If you bought a fixed annuity, then it will continue to pay its guaranteed rate of interest regardless of what happens in equity markets.
If you bought an indexed annuity, then you may not be credited with any interest for the period in which the underlying benchmark dropped in value (so your contract value would be locked in). If you bought a variable annuity, then your return will be based upon the returns that the subaccounts reaped during that time.
There is also a possible impact of fees to consider as well. Here is one question to ask. How would any fees that you are paying each year factor into the periods when the contract value goes down or remains the same?
It’s possible that your contract value could go down in a negative crediting period, but this is usually a rare occurrence. But, to be clear, your contract value could decline in those years.
The fees would reduce the value of your money in the contract. For example, if you are charged with a 1% fee for death benefit protection, then the value of your contract will be assessed that fee at the end of the year.
13. If This is a Fixed or Indexed Annuity, What is the Guaranteed Minimum Rate?
Say you are considering a fixed annuity or an indexed annuity for your situation.
If you are looking for your money to grow, it’s good to clarify what the minimum guaranteed interest rate will be in the contract. Also, ask about how long this guaranteed rate lasts for.
Fixed annuities are plain vanilla in this regard, as they will credit the guaranteed interest rate to your money, no matter what. It’s about as straightforward as it gets.
If you are considering an indexed annuity, you will want to know how the insurance company fares with giving you competitive growth potential in the years ahead. While not all insurance companies give their renewal rate history, you can ask your financial professional if this history is available.
Most life insurers offering fixed indexed annuities don’t have a guaranteed minimum rate of growth. Rather, they will have a fixed guaranteed growth rate, based upon current interest rates. This fixed-interest bucket will be among other index-based strategy options for crediting interest to your money.
If a fixed indexed annuity insurer guarantees a minimum rate of growth, then there will be one, regardless of how the underlying benchmark does during a given crediting period. Your issuing life insurance company should have a solid issuing history regardless of the fees they may assess.
14. What Are the Other Pros, Cons, and Potential Mishaps with This Annuity?
The worst thing that could happen when you purchase an annuity is the realization that you should have done something else. For example, say you bought the wrong annuity and realized, post-sale, that you should put your money in a more liquid instrument.
The optimal use for an annuity is for retirement goals: accumulating savings, growing your money guaranteed, receiving an assured permanent income, or protecting your money from market loss, among other objectives.
So, if your goal isn’t related to retirement, than an annuity probably isn’t right for you. You can’t withdraw more than the stated value of your contract without a penalty before age 59.5.
15. Does My Financial Advisor or Annuity Agent Give Me Confidence?
Your financial professional is the one making the recommendation to you. They should have your confidence and trust in their recommendation.
Do they give you the assurance that they understand your retirement needs? Are they acting in your best interest? Are they making a recommendation that will solve a clear, definitive problem or set of problems in your current financial strategy?
Sometimes this can be a difficult question to answer. Your financial advisor or agent may give you a complicated answer to your financial problems.
An annuity will pay your advisor a commission. But, over the lifetime of which your annuity is solving the problem, your real cost per year will probably be less than what you would have paid in money management fees.
What’s more, this payment comes from the insurer’s coffers. 100% of the money you put into the annuity goes to work for you from day one.
If your advisor is also a financial planner, you may pay them an additional fee for a comprehensive plan they put together for you, too. What’s more, if your advisor will also manage your money in mutual funds, ETFs, or other managed-money products, you may also pay them money management fees for this value they are providing to you as well.
Your financial professional can clarify how they are paid for different services they might provide to you.
Making the Right Decision for Your Retirement
By making the right choice, an annuity can bring stability and certainty to your overall retirement plan. The guarantees of an annuity aren’t like anything you will find elsewhere. Life insurance companies also have upheld these contractual guarantees well to millions of policyholders over the years.
Are you ready to see what the right annuity can do to help you reach your goals? You can start by requesting an initial appointment about your overall situation with one of many independent financial professionals available here at SafeMoney.com.
Use our “Find a Financial Professional” section to connect with someone directly. You can talk about your unique goals, concerns, and situation with them in your initial meeting. Should you need a personal referral, call us at 877.476.9723.