First Things First: Annuities 101

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What would you guess is the number one reason why people decide not to purchase a fixed index annuity with an income rider as part of their overall retirement income plan?

It’s not because of surrender charges, fees, or lower returns. It may be because the benefits of a fixed index annuity with an income rider can simply sound too good to be true:

  • How can your principal actually be protected against all stock market losses, when you have never had, or been offered, this benefit before?
  • How can your income be guaranteed to be paid to you for as long as you live, even past age 100, and even if your account value reaches $0 when you have never had, or been offered, this benefit before?
  • How can you earn a portion of index gains when the market goes up but never ever lose any of your current or previous gains from future losses, when you have never had, or been offered, this benefit before?
  • How can you reduce the total fees you pay to an average of 1% when you have never had, or been offered, this benefit before?
  •  How can all these things be true when you have wanted all of these benefits for a long time, but no one has been able to provide them to you?

Here’s the key: a fixed index annuity with an income rider is not too good to be true, you do get all these benefits. It’s how they work. It’s why they were designed. Our goal is to provide you with a clear, factual, understandable explanation of fixed index annuities with income riders. Our definition of “understandable explanation” is a fair and balanced analysis which includes an accurate description of what a fixed index annuity with an income rider is, how it works, the advantages, the disadvantages, and multiple case studies showing different uses and applications for a fixed index annuity with an income rider based on different circumstances.

What really is a fixed index annuity with an income rider? An extremely summarized version of a definition for a fixed index annuity with an income rider is: a contract with an insurance company that can be funded with cash (after-tax money) or IRA money, guarantees your principal against all stock market losses regardless of severity, protects all previous and current gains against all future stock market losses, guarantees your income for as long as you live even past age 100, provides you an opportunity for a portion of index gains, provides income tax deferred growth of all earnings, is subject to surrender charges limiting your total liquidity, limits your overall returns providing lower returns than the stock market, taxes gains as ordinary income, and carries an annual fee (in most cases) to guarantee your income for life.

An annuity is defined as follows by www.merriam-webster.com as: a fixed amount of money that is paid to someone each year. Isn’t that what retirees and pre-retirees want from their money? What is one desire retirees commonly have for their money? It’s to receive income for as long as they live, guaranteeing they will never be without income, thus eliminating their fear of running out of income. An income rider is an additional benefit you can add to your fixed index annuity that carries an annual fee (in most cases). The main purpose of the income rider is to guarantee your income, and your spouse’s income if married, for as long as you live, regardless of market performance, how long you live, or how much money remains in your account. Buying an income rider is simply buying insurance to guarantee your income will never run out for as long as you live.

Think about this, if you are like many retirees we meet with, your biggest fear may be running out of money before you die, and even if you have had an advisor for many years, you may not know you could buy insurance that guaranteed your income for life, for a relatively low overall total annual cost, typically averaging 1%. We have often found retirees and pre-retirees can buy an income rider to guarantee their income for life, and pay lower overall fees than they are currently paying on their current assets with no income guarantees. An income rider will guarantee you will not run out of money, guaranteeing income will be paid to you for as long as you live.

The word “annuity” is very polarizing to consumers with some people seeming to love them and some people seeming to hate them. The authors respectfully believe that the majority of the negative opinions about annuities, whether it be from an advisor, consumer, or media source, are based on a minimum amount of facts and a maximum amount of conjecture. We have found that many people who aren’t experts on annuities want to give you their opinions on annuities, and you may have heard the crude old saying about everyone having an opinion. To be more politically correct, we created our own saying:

Opinions are like armpits, everyone has two, and it is safer
to stay away from both of them!
~ Dan Ahmad and Jim Files

While our saying is not as famous as the comments below, we just believe they mean about the same thing:

Opinion is the medium between knowledge and ignorance. ~ Plato

Beware of false knowledge; it is more dangerous than ignorance. ~ George Bernard Shaw

Ignorance is the curse of God; knowledge is the wing wherewith we fly to heaven. ~ William Shakespeare

By giving us the opinions of the uneducated, journalism keeps us in touch. with the ignorance of the community. ~ Oscar Wilde

While many people may want to give you “their opinion” on annuities, our book, Momma’s Secret Recipe For Retirement Success does not give you opinions, it gives you cold, hard, facts. Facts about the stock market, risk, returns, fees, taxes, asset allocation, having a written plan, and now a whole factual section on fixed index annuities with income riders. On the website of the SEC – Securities and Exchange Commission, the SEC defines annuities as:

An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.

Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates. If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties.

There are generally three types of annuities – fixed, indexed, and variable. In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.

Variable annuities are securities regulated by the SEC. An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the SEC. Fixed annuities are not securities and are not regulated by the SEC. You can learn more about variable annuities by reading our publication, Variable Annuities: What You Should Know.

We have provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities law.

Sometimes consumers tell us they have heard that annuities are not good for them. We will then ask them:

  • What kind of annuity are they referring to?
  • Are they talking about an old-style single premium immediate annuity with life only payments?
  • Are they talking about an old-style single premium immediate annuity with time specific payments?
  • Are they talking about a fixed deferred annuity?
  • Are they talking about an equity indexed annuity?
  • Are they talking about a hybrid indexed annuity?
  • Are they talking about a variable annuity without an income rider?
  • Are they talking about a variable annuity with an income rider?
  • Are they talking about a fixed index annuity without an income rider?
  • Or are they talking about a fixed index annuity with an income rider?

Of course, they have no idea what type of annuity they are talking about. They typically respond they didn’t know there was more than one (1) kind of annuity or that they just thought, or have been told, all annuities were bad. We will be focusing on educating you about fixed index annuities with income riders. We may mention life-only annuities, variable annuities, variable annuities with income riders, immediate annuities, fixed annuities, equity index annuities, hybrid annuities, single premium immediate annuities, or fixed indexed annuities without income riders, but we will be focused solely on educating you on exactly what a fixed index annuity with an income rider is, what it does, what it isn’t, and how it works.