Five questions you should ask before buying a Fixed Annuity.
Annuities can be very useful for some investors and a poor choice for others, depending on the specific financial needs. Perhaps the most important step to purchasing an annuity is to educate oneself on the pitfalls and negative aspects within the contract. A good financial planner will always make these aspects clear to you; however it is always helpful to know which questions to ask.
If you are going to look into annuities as a retirement or and an investment option, make sure it fits into your needs and parameters.
Questions to ask when buying annuities:
1. How Long is the Surrender Period:
The length of annuity contracts can range anywhere from one to fifteen years and almost all annuities will impose a ‘surrender charge’ for closing the account early. Typically the longer the surrender period, the better the rate of return you should expect. This works much like traditional bank accounts in the sense that checking accounts give very little interest, but allow access to virtually the entire account at any given time, while a saving account or CD will pay hirer interest but limit availability of the finds. Typically the surrender charge will decrease over time; so for example canceling a policy in the 8th year of a 10 year contract will encore a far lower penalty then it would in the first few years. Think about when you will need access to the funds, and ask your financial planner to show you annuity options that fit that time frame.
2. Does the annuity include a first year bonus:
Some annuity companies offer premium ‘bonuses’ on your first year deposit into an annuity. The insurance company adds anywhere from 2% to 10% to each of your premium payments, which can make for an excellent head start. For example, if you invest $100,000 in a bonus annuity with a 5% ‘bonus’, your accumulation value day one would be $105,000. The trade-off is that with a bonus annuity the surrender period is usually longer and each subsequent bonus payment will have its own eight or nine year surrender period.
3. What is the Financial Rating of the Insurance Company:
An annuity by definition is a contract guaranteed by an insurance company. Annuity consumers sometimes forget this and buy and annuity without factoring the claims paying ability of the insuring company. This does not only apply to the questions of solvency or bankruptcy but to the more subtle effect it might have ones contract. If an annuity company has financial trouble it most likely will not go bankrupt (even though it is a possibility) because of the various government regulatory groups that monitor annuity companies. But what can happen is the annuity company will lower the rates at which it credits interest to your account in order to make up its losses in other areas of its business.
4. Does the Annuity Offer Penalty Free Withdrawals:
Most annuity products allow the owner to take a portion of the account value out without penalty within the surrender period. Typically 10%-15% will be available per year; however this will vary from annuity to annuity. The free withdrawals are not affected by the surrender charge and can be used in times or emergency or as schedules withdrawals for income purposes.
5. What is the Interest Rate and How Long is the Guaranteed Period:
Traditional fixed annuities will offer a set interest rate; however that rate will often only be guaranteed for one year. The insurance company will reserve the right to raise or lower the rate, so be sure you know what the interest rate can go to later in the contract, not just what the rate is when you purchase it. Fixed Indexed Annuities calculate interest based on the performance of an index (i.e. s&p 500), which means the rate of return will be different each year. The performance of these types of annuities are hard to predict, but historical illustrations can be used to show the rate of return in past market conditions.