Before determining what questions to ask in purchasing your annuity, first it is important that you understand the purpose of an annuity. Annuities are an investment vehicle that will eventually create an income stream for as long as you want, similar to a pension. Because the product is an insurance product, it also makes the money transferable to your beneficiary easier after your death, so have a beneficiary in mind.
Another question to ask yourself is when will I want or need to access money from this account? If it is before 59 and a half, an annuity likely isn’t the best vehicle for you because there are steep penalties of 10% for early withdrawals (like a 401k or IRA) and also you could be facing surrender charges if you owned the product less than 7 years. If your goal is to have a retirement nest egg that you can create a stream of income for after 59 and a half that is easy to pass on to beneficiaries, you are likely a candidate for an annuity.
The first question you should ask is what type of annuity is appropriate for me? The types include Fixed Annuities, Variable Annuities, and immediate annuities. Each have different pro’s and cons and are appropriate for different investment scenarios and goals. A fixed annuity allows you to earn a fixed rate of return for the life of the contract (all though that return can fluctuate based on interest rates) similar to a CD, usually slightly higher.
A variable annuity allows you to invest your money into a portfolio of managed mutual funds, but will have higher fees to pay for the professional money management your receiving from the mutual funds. An immediate annuity is appropriate if you are already 59 and a half and have a pot of money in a 401k or IRA and want to create an immediate income stream for yourself.
After you’ve established the type of annuity that is appropriate for you, your second question should be, what are the surrender charges for this annuity, and how long are they in place? Generally the surrender charges go on a decreasing scale from 7% down to zero, decreasing one percent each year you own the product and by the 8th year are eliminated. Keep in mind these fees still exist even after you’re 59 and a half if you have owned the product seven years or less. Meaning, if you buy into a fixed annuity at 55, and you start taking withdrawals at 60, its likely you’ll still owe a 2% surrender charge on your money.
What other fees will I be looking at in my annuity? Annuities have a mortality and expense (M&E) fee that is approximately 1.15% per year that the insurance company charges to guarantee your income and cover administrative costs. Usually that fee is factored into a fixed annuity’s interest rate, but I would confirm this with the insurance company before purchasing. In a variable annuity you will have this fee on top of the money management fees mentioned earlier, so you really need to analyze your net rate of return and tax savings to see if an annuity is a good investment for you.
What are the track records of the investments in my variable annuity? Variable annuities have a portfolio of mutual funds to choose from to diversify your investment. You’ll want to look closely at their levels of risk, past return performance for at least a 3-5 year period. You can use outside websites like the Wall Street Journal and Morningstar to find a funds previous history.
What are my options for payout? You’ll want to know how often you will receive a check from this account and for about how much when you start to receive payment. There are a very flexible number of options, including lump-sum, periodic monthly payments for a varying number of years, life payments, and even life including survivor (payments for as long as your spouse lives if you should pass before him or her). Get an estimate as to what these payments will be based upon a reasonable to conservative rate of return. This way you can plan accurately how much of your retirement income you can count on from your annuity and for how long.
Finally, what is the insurance company’s rating? Understand that even if you invest in an annuity in your 50’s or 60’s, it is a partnership with that insurance company for decades. You will be relying on them to guarantee your income for years, and possibly pass money efficiently to your beneficiary. All insurance companies are not equal. Is your company financially secure and have a sound rating? Check Standard and Poor’s and Moody’s to verify your company’s overall rating and compare it to its peers. You can also check with your state’s department of insurance, or Morningstar once again. If you’re going to count on this for your retirement income, make sure the company will be there for you when its time for them to pay up.