As annuities are so often misunderstood as an investment vehicle, I felt compelled to give people, who may otherwise miss out on a great investment option, a better understanding of this product.

What are annuities?

Simply put, Annuities are investment products that have an insurance component and are backed by the financial strength of an insurance company. As soon as the word insurance is mentioned, though, many people who are looking to invest money clam up. After all, they want an investment not more insurance. What some fail to grasp though, is that, ultimately, what matters, is that the money you invest with a company has the potential to yield the best possible results for the risk taken. Annuities can do just that.

In other words, if an annuity company is willing to offer you a rate of 5% (net, after all costs) guaranteed for five years and your bank or mutual fund company offers you 4.5% (net), which will you choose? Believe it or not, many will choose the plan with 4.5% interest simply because it does not have the word insurance mentioned in it’s plan structure. Seems crazy, no? We think so too! And in times of turbulent stock markets and low bank CD rates, annuities can be a great investment alternative. Annuities offer a measure of protection against market downturns, may provide a guaranteed investment return, and grow tax-sheltered until you withdraw the money.

The Lock in Period

One important aspect of annuities is the lock in period. That simply is the time period that you agree to keep your annuity plan with the same company. You can withdraw out of this annuity before the end of the guarantee period, but you may incur a stiff penalty (which varies from plan to plan). In other words, if you select a five year annuity and decide to cancel the plan after two years, you may have to pay a 3% penalty (varies). That penalty can apply to the original amount invested or the original amount invested plus the interest earned during that period. The lock in period or surrender charge period should be well detailed in your annuity policy. Although, 10 year and longer polices are popular with agents and brokers, we do not recommend that you lock in your policy for longer than five years. Some annuity plans do offer a 5% to 10% free withdrawal option during the lock in period.

Types of Annuities and their functions

The basic fixed annuity – This type of annuity is often called Interest Only Annuity or CD Annuity. With these annuities, the insurance company guarantees a minimum rate of return for designated period of time. The most common guarantee periods are four to ten years, but we have also seen, one, two and three year guarantees. These are often used as alternative to bank CDs.

The Bonus Annuity – The bonus annuity simply offers a bonus at the time of application and sometimes with any subsequent deposits. So if you invest $100,000 into a 10% bonus annuity, your annuity value will now be $110,000. The higher the bonus the longer the lock-in period. For example, a 10% bonus annuity often has a 10 to 12 year lock-in period. Bonus annuities are often popular with people who have lost money with other investment and try to make up for the loss.

The Indexed Annuity – This type of annuity is fairly new and has been a wonderful addition to the annuity portfolio. Indexed annuities can be a bit complex and selecting one can be confusing. For the sake of simplicity, we cannot cover all options in this article but, simply put, an indexed annuity is a fixed annuity which credits interest based upon the performance of index (as opposed to a fixed interest). For example, an indexed annuity that offers a 60% participation in the S&P 500 index, may credit 60 percentage of the gains in that index for the year. If the gain for the index at the end of the year is 15%, then you may be credited an interest of 9% (60% of the index gain). An important aspect of indexed annuities is that, as long as you keep for the full period you selected, you usually cannot loose your principal and gains. For example, if the index for any period is minus 10%, the interest credited to your account is simply zero (not -6%).

The Income Annuity – This particular annuity is very popular with retirees – age 65+. As its name indicates, the main purpose of this annuity is to provide you with an income. As with indexed annuities, these annuities offer many options. The most popular option, though, is the life income option. With that option, if you deposit money with an insurance company, the insurance company will, in turn, guarantee a certain income for life. Payouts on income annuities can vary greatly and it is very important to shop many plans and options before sending your hard earned money to an insurance company. With some annuities, once you accept the policy, your money may be locked in with the same company for life. Make sure it is a solid insurance company!

The variable Annuity – This type of annuity may have been what spurned the creation of indexed annuities. Simply, a variable annuity is a fixed annuity with a variable investment option built in. Variable investments can be mutual funds, bonds…. Variable Annuities are the most complex of all annuities and we recommend that you ask a lot of questions and speak to several agents before making a final decision. Although you can cancel the plan at any time, penalties can be the largest of all annuities mentioned. It may be possible to loose substantial amounts of money with variable annuities.

Annuity Riders

The most common riders are the Death Benefit Rider which guarantees a certain pay out amount at the death of the annuitant and Living Benefit Rider which adds guarantees to the cash value of the policy.

Cancellation period

All annuity plans offer a cancellation period. That is the amount of time you have available to cancel the annuity without any early withdrawal penalties. Please beware that, if your annuity is in a tax qualified retirement account (IRA, 401K rollover…) you may need to roll over the money from the annuity to another tax qualified account to avoid tax penalties.

We hope this basic explanation about annuities and how they work will be helpful in your search for the annuity that is right for you and your goals. As with any financial decisions, please ask many questions before making a final decision. You should also a full proposal and don’t spend too much time on fliers and pamphlets. Proposals should have all the information you need. Please, do not hesitate to ask us as many questions as you need to. Our response will be unbiased and quick. We wish you long life, health and wealth.

Philippe Deray – About the Author:Philippe Deray is President and CEO of MCD Financial Services and MCD Life. Our web site address is http://www.mcdlife.com/annuities/annuities.htmlOur Focus is providing unbiased information on annuitiesWith many years of experience in the insurance business, we have helped many individuals find the annuity information and plan options to help them make more informed investment decisions. In all situations, we recommend that you contact multiple advisors before making a final decision. Company ProfileMCD Life is a successful, dynamic company built on the principal of serving our customers FIRST! Our primary mission is to bring peace of mind to our clients by offering innovative, value-added information on insurance products to assist them in their short and long term decisions. We constantly strive to offer companies that offer quality products.
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