Annuities can be a tricky purchase. There are many different products – fixed
annuities, variable annuities, tax-deferred annuities, guaranteed annuities,
inherited annuities, equity indexed annuities and more.
These terms generally refer to the different features that can be applied to the
basic annuity product. Some of these features are great for retirees and are
options recommended by the most respected financial planners. Other annuity
features are almost universally condemned by these same planners. As such, it is
important for you to understand how to choose the right annuity for you and your
Below you will find the issues that are important to consider when evaluating
annuity features and comparing providers.
Fixed annuities and variable annuities
Perhaps the most important consideration to make when evaluating annuities is
whether to choose a fixed or variable annuity.
Fixed Annuities: Fixed annuities are typically based on fixed income products
like bonds and pay a guaranteed stream of income. With a fixed annuity, your
income stream is "fixed" or guaranteed. You know how much income you will
receive every month when you finalize your contract.
A fixed annuity guarantees you a certain income – no matter what – which makes
them a good bet for retirement financial planning. Guaranteeing your income to
cover your basic expenses in retirement is a good retirement financial planning
With a fixed annuity you can also elect to pay extra for an annual Cost of
Living increase or inflation protection as an option on the annuity contract.
Variable Annuities: Variable annuities are typically based on mutual funds and
pay a stream of income that moves up and down with changes in the value of the
underlying fund. A variable annuity is a riskier investment for retirement.
Which is the Best Product for Retirement? Fixed or Variable? Many financial
retirement planners will recommend that their clients purchase a fixed annuity.
Fixed annuities are less risky and provide a more reliable income stream.
Lifetime annuity or term annuity
Lifetime Annuities: Lifetime annuities are annuities that pay an income stream
for the remainder of your life – no matter how long you live. In fact, depending
on how long you live, a lifetime annuity could pay you a higher sum over your
lifetime than you originally invested in the annuity. Of course, the opposite
might also be true – you could die before you have recouped your investment.
(However, many annuity products offer premium protection – insuring that you or
your heirs will receive back at least as much as you invested.)
Lifetime annuities can be a good bet for you if you need to guarantee additional
income beyond your pension(s) and/or Social Security payments to cover your
basic expenses for the rest of your life.
Term Annuities: Term annuities are annuity products that pay you an income
stream for a specified period of time – 5 or 10 years for example.
Which is the Best Product for Retirement? Lifetime or Term? Unless you know how
long you will live or know that your income needs will decrease as you age, a
lifetime annuity is the best bet for most retirees. A lifetime annuity
guarantees your retirement income indefinitely.
Other Points to Consider When Evaluating and Comparing Annuities
Company Rating: Your annuity should come from a reputable and highly rated
annuity company/insurance company.
Annuities are a long-term investment and the federal government does not
guarantee these products. You need to be confident that your insurer will be
around 20 years from now. You need income for the rest of YOUR life – not the
lifetime of the insurer.
Premium Protection: You should consider an annuity with premium protection.
Premium protection is a feature that guarantees you to receive in premiums at
least as much money as you originally invested.
With premium protection, you will continue to receive periodic annuity payments
until the cumulative annuity payments equal your net investment. (If you die
beforehand – your heir(s) will receive the payments.)
You can choose higher lifetime income payments each month by forgoing premium
protection, but there's no guarantee that you will recover all or part of your
original investment in the annuity.
Cost of Living Protection: Most financial planners would strongly recommend that
you choose an annuity with automatic cost-of-living adjustments.
When you buy an annuity, you are buying a certain amount of monthly income.
However, inflation can dramatically decrease the buying power of that income
over time. An annuity with "cost of living adjustments" (COLA) protects the
value of your income stream by adjusting your payments along with inflation or
the cost of living. Inflation protection or cost of living adjustments afford
you the ability to maintain your lifestyle in retirement.
Joint and Survivor Benefits: Annuity products can be tailored to accommodate one
person or a family. If you are married, you will probably want to purchase an
annuity that guarantees your own income – as well as your spouse's financial
welfare after you die.
Tax Implications: The purchase of an annuity with qualified retirement savings
(401k or IRA funds) can save you money on taxes over taking a lump sum payment.
You can roll-over qualified funds into a qualified annuity without any tax
penalties. You only pay taxes on the income the annuity provides.