Fixed Annuities - What to Know and Expect

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The Process:

    Prior to Purchase:

1. Consider maximizing contributions to other tax-deferred accounts prior to contributing to an annuity?
2. Determine whether an annuity is an appropriate investment vehicle or if other investment options (i.e. TIPS or Variable Annuities) may be more appropriate for your unique future financial goals and objectives.
3. Get a second opinion from an educated, unbiased source.  Consult someone other than the salesperson trying to sell you the annuity such as a Certified Financial Planner™.
4. You must choose whether to make a single lump-sum premium payment or to make periodic premium payments.
5. You must select either an immediate annuity that will start paying you payments immediately or a deferred annuity that will make payments to you sometime in the future. 
6. You should shop around to determine which insurance company offers the best value (compare).  Compare the guaranteed rate of return and the guarantee period, the maximum annual withdrawal benefit, the surrender period, the insurance company's financial strength ratings, etc.  Working with an advisor that is not a captive insurance agent can be beneficial to help evaluate the strengths and weaknesses of the issuing insurance company and may help to uncover other concerns you may not be aware of.
7. Maximum issues age - If you are over a certain age, you may not be able to purchase an annuity.  Find out what the maximum issue age is.

    The Purchase:

1. Select your initial guarantee period.  Selecting a longer guarantee period locks in the guaranteed rate of return for a duration of time.  However, the longer the duration; the higher and longer the withdrawal charges can be based on the surrender charges of the contract.
2. If interest rates are on the rise, a shorter guarantee period may be favorable.  If interest rates are falling, longer guarantee periods may be favorable.
3. Various Options:
   • Withdrawal interest only - Allows monthly systematic withdrawals equal to the interest credited during the previous contract month without withdrawal charges or Market Value Adjustment (MVA).  This can be stopped or started at any time.
   • Riders are usually elected at issue and are usually irrevocable.
   • Riders allow for additional benefits for a fee that lowers the credit rate.  For example: to increase liquidity, an insurance company may allow you to access a portion of your money up to a certain percentage (e.g. 10%) without incurring withdrawal charges or a Market Value Adjustment (MVA).
4. Some companies pay a one-time bonus that increases the initial interest rate to entice investors. To offset the cost, the investor pays higher management fees minimizing if not eliminating the perceived benefit over time.  In addition, expect higher surrender charges and longer surrender periods as well as lower renewal interest rate.
5. No initial sales charge.  100% of your investment begins to earn interest immediately.

     What to Expect after the Purchase:

• Tax-deferred growth.
• A 10- to 30-day window to cancel contract from the beginning of the contract or contract renewal.
• A minimum guaranteed interest rate, which usually ranges between 3 - 4%.
• Changes in the guaranteed interest rate - Your fixed interest rate is only guaranteed for a specified period of time (guaranteed period) usually 1-7 years.  As each “guarantee period” comes to a close, the insurance company sets a new interest rate for the upcoming period. Interest rates and time periods vary depending on the annuity contract.
• The stated rate is usually an effective annual rate, not a nominal rate that is compounded periodically. For example, if you put $1,000 into an annuity with a 5% declared interest rate, you’ll have a year-end account balance of $1,050, not a higher amount due to compounding.
• At the end of your guarantee period, you have the option to renew for a different guarantee period or to withdraw all or a portion of your money.  Surrender charges may apply.
• Tax-deferred growth - earnings in a fixed annuity accrue without taxation and are taxed as ordinary income when withdrawn.   

     Distributions During the Annuity Contract:

1. Surrender the contract and receive a lump-sum distribution.
2. Take a withdrawal
3. 1035 Exchanges
4. Annuitize the contract.

• Surrender penalties - A surrender penalty is a charge that is applied to distribution during the surrender period in excess of the withdrawal benefit.  The penalty is assessed as a percentage of the amount withdrawn.  Annuity surrender periods very as well as the penalty percentage.  The penalty percentage is based on a decreasing scale meaning distributions penalties taken in the first year will be higher than distribution penalties taken in later years.  After the surrender period ends, there are no more surrender charges. However, if new investments are made to the annuity, new surrender charges will apply to the new contribution.
• Market Value Adjustment (MVA) - Some fixed annuities increase or decrease the surrender value to reflect gains or losses on the insurer’s own investments as a result of changes in interest rates. The annuity contract contains the market value adjustment formula. The formula is usually not symmetrical; the reward if interest rates go down is usually less than the penalty if interest rates go up.  The MVA does not apply in all states.
• Withdrawal benefit - Most annuities will allow you to take a maximum annual withdrawal without incurring any surrender penalties.  These are called free withdrawals and can be as high as 10% of the total annuity value.
• Withdrawals/Distributions - May be totally or partially taxable at ordinary income tax rates (consult your tax advisor).
• Early Distributions - Distributions taken prior to age 59 1/2 may incur an additional 10% tax penalty (consult your tax advisor).
• 1035 Exchange - Allows the owner of an annuity contract to transfer the current annuity contract to a new annuity contract without creating a taxable event.  
• Annuitization - You can convert your account balance into a stream of fixed income payments for life (a MVA may apply).  Several options exists:
  1. Life Annuity - An individual "life annuity" makes payments as long as you live, so you can't outlive your income. On the other hand, payments stop when you die—even if that occurs the day after you receive your first payment.
  2. Period Certain Annuity - A "life annuity with period certain" guarantees payments for life but pays for at least a specified number of years.
  3. Life Annuity with Period Certain - A "term certain" or "period certain" annuity makes payments for the period you elect and then stops. If you die before the end of the period, your named beneficiary or beneficiaries will receive payments for the remainder of the guaranteed period.
  4. Joint and Survivor Annuity -A "joint-and-survivor annuity" makes lifetime payments to you and your spouse while at least one of you survives. Some contracts also offer a joint-and-survivor annuity with a term certain feature.
  5. "Systematic withdrawal," available under some annuity contracts, lets you arrange to receive designated amounts and change those amounts from time to time. You can't be sure of receiving lifetime income under this arrangement, but your beneficiaries will receive any amount left in the account when you die.

• No Guaranteed Death Benefit - Fixed annuities do not offer a guaranteed death benefit. If you die before payouts begin, your beneficiary(ies) receive the current contract value of the annuity. Once you’ve begun receiving payments, the amounts paid to beneficiary(ies) depend on your payout agreement.  Riders do exist that may provide an additional death benefit.

• Avoid Probate - To avoid probate, a beneficiary(ies) must be named (consult a CFP^® or estate planning attorney for beneficiary options and estate and income in respect of a decedent (IRD) tax consequences of each).  

A few companies that offer Fixed Rate Annuities:

• MetLife
• Genworth
• Principal
• John Hancock
• Pacific Life

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