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Investing for Retirement with Annuities

What is an Annuity?

On a basic level, annuities are insurance products, purchased from an insurance carrier, that are designed to help protect your retirement income from risks like market exposure or outliving your money. Annuities are a tax-deferred investment product offered by insurance carriers and are typically used during retirement years. The main advantages of annuities are their tax-deferred feature, which allows an annuity owner to accumulate more money as compared to fully taxed investments. Also, annuities give the owner the benefit of growing their investment in a safe and secure investment instrument that will guarantee the gains accumulated cannot be lost. 

An Annuity is a sum of money payable yearly or at other regular intervals. The actual amount of money is based upon a contractual relationship between the person covered called the Contract Owner, and by the annuity insurance company called the Insurer, through which the investment is made. Annuities have been around a long time. They have been available in the United States for more than 100 years, and several hundred years in some other countries.

Although annuities are sold only through the insurance industry (i.e., insurance agencies, brokerage firms, investment advisors, financial planners, banks, savings and loans institutions), they have nothing to do with life insurance or insurance coverage.

Investing with Annuities

Anyone can sell you an annuity; however, it takes a truly qualified and experienced advisor to know how to structure them for income, inflation, growth, return of principal, and tax advantage. Typically, a person buying one annuity will not fix all of their income and retirement needs; rather, it will take a financial plan including an income source, life insurance, emergency funds accounts, possibly an annuity, and other financial tools to build a robust financial portfolio. It may take multiple types of other financial tools, including possibly multiple types and differently structured annuities, to balance your portfolio and achieve your financial objectives.

Annuity Protection/Guaranty

Similar to a bank account in the United States having the FDIC Insurance backing, if an individual purchases an annuity, he/she is protected by a state guaranty association in the unlikely event the insurance company has financial trouble. Guaranty associations are created by state law, to assure that the claims of an insolvent insurance company’s policyholders, who live in the state, will be paid, subject to the limits of the law. All insurers authorized to write life insurance, health insurance, and annuities in the state are required to be members of the association. 

Types of Annuities

There is a wide range of annuities with varying options and features. All annuities are divided into two basic types: Fixed or Variable. However, there is also a hybrid type called a Fixed Indexed Annuity, which has the characteristics of both a fixed and variable annuity.  

Immediate Annuity (Sold by Licensed Insurance Agents)

If a set rate of return is desired, the contract owner should choose the Fixed Annuity. This type of annuity guarantees that the money will accumulate at a minimum specified rate of interest. However, the insurance company will pay a higher rate of interest if its investment experience is better than the minimum guarantee.

Fixed Indexed Annuity (Sold by Licensed Insurance Agents)

This type of annuity is a hybrid called a Fixed Indexed Annuity. It is a tax-deferred long-term savings option that provides principal protection in a down market and opportunity for growth in an up market. It gives you more growth potential than a fixed annuity along with less risk, but less potential return than a variable annuity. Returns are based on the performance of an underlying index, such as the S&P 500® Composite Stock Price Index, a collection of 500 stocks intended to provide an opportunity for diversification, and represent a broad segment of the market. While the benchmark index does follow the market, even being an investor, your money is never directly exposed to the stock market; consequently, there is no loss of the gains you have accumulated.

Variable Annuity (Sold by Certified Financial Planners CFI) (We don’t offer this type of Annuity at Healthcare American)

If a more conservative to aggressive investment is desired, the contract owner can choose the Variable Annuity. In this way, the owner can decide where the money should be invested. These annuities also have death benefit provisions, including the attractive element of providing an insurance company guarantee that an annuity holder is entitled to the face amount of his or her annuity contract, regardless of what happens to the contract’s investments.

Income Features of Annuities

The two major applications for the Contract Owner are the need for income and options for investment. The application required is dependent upon when the need for income occurs.

An Immediate Annuity

An immediate annuity can provide income, in some cases, in as little as 31 days after the purchase of the annuity. For example, if the contract calls for monthly installment payments, they will begin one month after the date of purchase. These annuities are specifically designed for those customers who need to receive a specific amount of money each month. These can be used as the sole source of income or as an income supplement. Payments may be made depending upon the need, on a monthly, quarterly, or annual basis. The amount of the check the client receives will not fluctuate, and the actual dollar amount of the checks is in direct relationship to the total annuity investment.

An important note to remember is if the insurance company is going to begin paying the annuitant shortly after the purchase of the contract, then the immediate annuity must have been paid by a single payment.

The market for annuities and large investments is very competitive. Several insurance companies should be contacted. Check rates and specific payout intervals (Example: five, ten, fifteen, and twenty years) on the intended annuity investment amount. Then compare the differences in the returns on the investment.

A Deferred Annuity

A deferred annuity is used to receive income payments at some further point in the future. It offers growth and flexibility for growth either over a long or short time. A deferred annuity can be paid for by a single premium, annually, semi-annually, quarterly, or by monthly installments over some time.

Unlike the “immediate annuity,” the deferred annuity payments to the annuitant begin after a designated period has elapsed from the purchase date.

The contract owner can receive a specific dollar amount of income each year and can direct how the balance is to be reinvested. This deferral process gives the contract owner the flexibility of automatic reinvesting, withdrawal of a portion of the principal, or termination of the investment.

Different Ways to Invest Money?

Both the fixed-rate and variable annuity have an accumulation period (effective the moment investments are selected) and a payout period.

Investment Options

A Fixed Indexed Annuity offers a wide range of investment options. The value of the investment varies by the value of the total investment performance. If fixed annuities guarantee fixed monthly amounts, monthly annuity payments vary, and will depend on the performance of the investment options, an annuity holder chooses. The fluctuation of the cash value is the main difference between Fixed Indexed Annuities and Fixed Annuities. 

A Fixed-Rate Annuity

Premiums paid for fixed-rate annuities are invested with the insurance company’s general funds, chiefly in fixed income types of securities, with the ultimate purpose of providing a level annuity income.

Though the fixed-rate annuity affords the contract owner a guaranteed rate of return, that rate is dependent upon the length of time the funds will be invested. Though the most common maturity periods for annuities are three and five years, the longer the commitment, the higher the guaranteed rate of return for the contracted period.

With a fixed annuity, the contract owner is protected against rising or declining interest rates, stock market gains or losses, and insurance company profits or losses by assuring the safety of principal and the exact interest the money will earn. This assurance is very appealing to the conservative investor, allowing the knowledge of specific projections.

However, the moderate to aggressive investor can utilize this type of annuity as a stabilizing factor in his overall portfolio. Using the guarantee that a fixed annuity allows, the diversified investor, along with other investments made (i.e., real estate, stocks, bonds, gold, mutual funds), is made to feel secure in his overall investment program.

A Fixed Indexed Annuity

A Fixed Indexed Annuity is a fixed annuity, either immediate or deferred, that earns interest or provides benefits that are linked to an external equity reference or an equity index. The value of the index might be tied to a stock or other equity index. One of the most commonly used indexes is the Standard & Poor’s 500 Composite Stock Price Index (the S&P 500), which is an equity index. The money can be placed in a credited fund account that is based on the index chosen in the stock market, such as the S&P 500. 

When you buy a Fixed Indexed Annuity, you own an insurance contract. You are not buying shares of any stock or index. While the growth depends on the growth of the index stock market fund chosen, the money is not invested in the stock market, and can never fall below the amount gained, which was accumulated in the fund account. Other fixed annuities also credit interest at rates set from time to time by the insurance company. Fixed index annuity’s credit interest using a formula based on changes in the index to which the annuity is linked. The method decides how the additional interest, if any, is calculated and credited. How much additional interest you receive depends on the features of your particular annuity contract.

Fixed indexed annuities, like other fixed annuities, promises to pay a minimum interest rate. The rate that will be applied will not be less than the minimum guaranteed rate, even if the index-linked interest rate is lower. The value of your annuity also will not drop below a guaranteed minimum. Fixed indexed annuities cannot lose the accumulated gains, but can lose value based on how much income is taken out of the annuity. While the funds are being depleted because of the income taken, the remaining funds left in the annuity continue to grow. While the remaining funds will not add to the income value, it will add to the death benefit or accumulated value. 

This type of annuity also offers riders that can be added, such as riders for a disability, nursing home stay, long term care, and terminal illness. Most annuities allow for withdrawal without surrender penalties up to a certain amount per year, and death benefit to survivor or beneficiary if funds remain. Fixed indexed annuities can grow tax-deferred without risking any of the accumulated gains.