Gamble Jones

Annuities: Know What You Own

After periods of heightened market volatility, conservative investors and those approaching retirement may be attracted to certain attributes of annuity contracts.  There are several types of annuities in the marketplace, including variable, indexed, fixed, deferred income, and immediate income annuities.

Generally, these types of annuity contracts are risk management tools rather than investments for maximizing returns.  As such, before purchasing any annuity, it is important to understand the guaranteed benefits, liquidity restrictions, investment options, and expenses in context of the contract’s purpose.

Assumed Benefits (Non-Guaranteed) and Guaranteed Benefits: Variable and indexed annuity illustrations use historical market performance data to project future benefits. But what if market returns are lower in the future?  To this end, it is important to compare the “guaranteed” benefits to the “non-guaranteed” benefits.  Are the “guaranteed” benefits acceptable?  Best Practices:  Compare the “guaranteed” and ”non-guaranteed” benefits to understand what the contract would provide in an unfavorable investment performance scenario. If the “guaranteed” figures are understood and satisfactory given your situation, the contract may be appropriate. 

Liquidity: Deferred and immediate income annuities are illiquid other than the periodic payments provided.  Fixed, indexed, and variable annuities will provide partial liquidity and are subject to surrender fees for a period that can range from four to ten years. Excess withdrawals from contracts with living benefit riders can erode the lifetime benefits and diminish the purpose of purchasing the contract in the first place.  Best Practices: Before purchasing a contract, be sure to understand the liquidity limitations and your own income needs.

Investment Options and Restrictions: While the investment responsibility of income annuities falls on the insurance company, indexed and variable annuities provide the investor a few options. In the case of the indexed annuity, the investor can choose one or more index benchmarks. The performance is usually based on the “point to point” appreciation of the chosen benchmark with a performance floor and cap.  With variable annuities, there can be a wide range of fixed income and equity mutual fund options. However, it is possible for the insurance company to limit your equity exposure if you purchased a living or death benefit rider. Best Practices: Understand the investment options allowed and investment limitations imposed by the contract.

Expenses: With income, fixed, and indexed annuities, the primary “expense” is the opportunity cost of an alternative investment as the returns of these contracts are either level or capped.  With variable annuities, there are multiple components to the cost, which include the mortality and expense risk charge, administration charge, investment (sub-account) charge, and rider charges (living and/or death benefit). These combined costs can be relatively high and create a high hurdle rate for account growth.  Best Practices: Understand the opportunity costs and expenses of the contract to ensure the benefits are worth the direct and indirect expenses.

Purpose: In the context of your financial and personal situation, what need is the contract designed to fulfill? Considering the expenses, investment options, liquidity rules, and guarantees, how likely is it that the contract meets your objectives?  Best Practices: Weigh the benefits and costs of the contract and how it fits with your financial plan.  

If you or a loved one needs objective guidance in weighing the costs and benefits of an existing contract or an annuity contract you are considering, please call at your earliest convenience.  This is where a trusted financial adviser can guide you to the decision that most fits your personal and financial situation.