An annuity is a long-term investment that’s costly and sometimes impossible to cancel. Make sure to carefully research before signing a contract’s dotted line by asking your adviser these questions.
1. How does an annuity help my retirement goals?
Start by having your adviser justify how an annuity improves your financial plan in the first place, says Kelly LaVigne, vice president of consumer insights at Allianz Life. If you’re considering one as an investment, what extra returns and benefits are you getting versus simply investing through your retirement plans and brokerage accounts?
This discussion is even more important if you’re considering an annuity to turn part of your nest egg into future income payments, as the annuity will lock up that money. “Your adviser should have software that estimates the probability of success of your plan with and without annuity income,” says LaVigne. In other words, how likely will you have enough income to last for the rest of your life?
The software will consider how you currently stack up with your expenses, savings, and other sources of guaranteed lifetime income, like Social Security and a pension. “Is there a major improvement with the annuity? Otherwise, it might not make sense,” says LaVigne.
2. What are the returns and performance guarantees?
A fixed annuity shows exactly what interest rate you would earn over a period of years, making it easy to compare companies. Top options are currently paying over 6% a year. You can also easily compare income annuities. Each insurer will tell you how much they’ll pay in annual retirement income based on your principal.
A fixed index annuity has returns based on a market index like the S&P 500, with limits on your gains and losses. A variable annuity invests your money in mutual funds. While your return depends on the market, the variable annuity may offer some guarantees. For instance, it promises a minimum retirement income regardless of investment performance.
Variable and fixed index annuities are complex and should be compared with the help of a professional. “The insurer gives a prospectus, but it’s a tough read. An adviser can walk you through the details,” says LaVigne.
3. What are the fees?
Fees depend on the type of annuity and the insurer. fixed annuities tend to have little to no fees. Variable and fixed index annuities can be significantly more expensive.
The annuity may have a surrender charge. If you cancel before an agreed-upon number of years, the insurer will deduct a percentage of your balance, potentially 7% or more. It’s a tradeoff with the return. “The longer the surrender period, typically the better the deal,” says Joel Russo, founder of NJ Retirement Planning in Sea Girt, N.J. Some insurers will let you take out a percentage of your money early penalty-free, such as up to 10% a year.
Ask your adviser if they earn commissions for selling the annuity. If so, what steps are they taking to prevent conflicts of interest? Check about non-financial incentives too, like the adviser qualifies for free trips by selling annuities.
4. What extra benefits are available?
Riders are additional benefits you pay to add to your contract, reducing your return or income. A few could be worth the investment.
You could add a cost-of-living rider so your retirement payments increase over time. In exchange, your payments start lower. “It usually takes six or seven years before you start collecting more than without the rider, but over a 30-year retirement, inflation protection makes sense,” says LaVigne from Allianz Life.
A long-term care rider increases your annuity income payments if you need long-term care. You could also purchase an enhanced death benefit, so more money goes to your heirs after you pass away. Alternatively, you could set up joint life income. Payments continue as long as you or the other person is alive. A joint life annuity could be a good idea if you’re married or have a long-term partner.
5. How does the annuity company stack up?
As you compare product details, pay attention to the insurance company itself. Check its customer satisfaction rating using services like J.D. Power and the Better Business Bureau.
You should also pull up its credit rating for financial stability from agencies like AM Best and Moody’s. Ideally, the carrier should have a credit rating of A- or higher, showing strong financial stability.
If you buy an annuity from an insurer that goes bankrupt years later, your state guaranty association reimburses you, but only up to your state’s coverage limits. You might not receive all your money and the full promised benefits back.“Go with carriers that have been around a long time with a high rating, even if lower-rated carriers may give better deals,” recommends Russo, the retirement adviser in New Jersey.
Note: This item first appeared in Kiplinger Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement. Subscribe for retirement advice that’s right on the money.
