Money grows tax-deferred with a floor of zero, then turns into payments that last for life. The shaded early years are the surrender period, when taking more than the free amount costs a charge. Illustrative, not to scale.
What it is
A fixed annuity pays a stated interest rate, guaranteed for a set period (often three to seven years), much like a bank certificate of deposit but issued by an insurer and tax-deferred until you withdraw.
A fixed indexed annuity credits interest based on the movement of a market index such as the S&P 500, with a floor of zero (you do not lose principal in a down year) and a cap or participation rate that limits what you earn in an up year.
Either type can be turned into guaranteed income for life, or carry an income rider that does so for an added fee. The income is a promise of the issuing insurer, which is why its claims-paying ability matters.
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Who it is for
- People within about 10 years of retirement
- Money you will need soon and cannot afford to see fall 30 percent in a bad year.
- Retirees who want a paycheck
- A guaranteed income that covers fixed expenses, so the rest of the portfolio can stay invested.
- Savers who have maxed out other tax-deferred accounts
- There is no contribution limit on a non-qualified annuity, and growth is tax-deferred.
- People who have already decided on safety
- If you were going to hold CDs or cash anyway, a fixed annuity may pay more. It is not for money you wanted in the market.
What it is not
- It is not a stock market investment. Indexed annuities are often sold as “market upside with no downside”. The upside is capped, usually well below the index’s full return, and dividends are excluded.
- It is not liquid. Most contracts allow a free withdrawal of around 10 percent a year; taking more during the surrender period costs a charge that starts high and declines over 5 to 10 years.
- It is not a fit for emergency money, or for money you may need before 59½, when IRS penalties can also apply.
- We do not place variable annuities. Those are securities and need a different licence.
The questions we ask
- When will you need this money, and for what?
- What else do you own, and how much of it is already safe? An annuity should be a slice, not the whole plate.
- Do you want growth, income, or principal protection most? The product follows the answer.
- Could you leave this money alone for the full surrender period without hardship?
- Is this qualified money (an IRA or 401(k) rollover) or after-tax savings? The tax treatment differs.
- Who should receive it if you die before taking the income?
Costs, fees and surrender charges
Fixed and indexed annuities usually have no explicit annual fee; the insurer earns its margin from the spread between what it earns and what it credits you. Optional riders, especially lifetime income riders, do carry explicit annual fees, often around one percent of the account value.
Surrender charges are the real cost to understand. Withdraw more than the free amount during the surrender period and you pay a charge that may start near 10 percent. Some contracts also apply a market value adjustment. We will show you the schedule in the contract before you sign anything.
Commissions on annuities are paid by the insurer and are larger than on most term life policies, and longer surrender periods generally pay the agent more. We will tell you what the agent is paid on any contract described.