Most Americans Don’t Understand Annuities; Decoding the Mystery of How Does an Annuity Work

decoding annuitiesWhile 71% of Americans say they would consider buying an annuity to meet a variety of needs, more than half admit they don’t understand the product, according to a survey by Phoenix Companies, Inc., a financial services firm.

Annuities are used for a number of reasons, but about half (49%) of survey respondents indicate they would purchase one to secure a predictable source of monthly income for retirement. Others would purchase an annuity to leave money for their spouse or heirs (41%), to provide money for chronic health care expenses (36%) or for asset accumulation (31%).

Still, one-quarter of survey respondents said they wouldn’t consider purchasing an annuity for any reason — and 53% admitted they weren’t familiar with the product.

That may be attributed to some common misconceptions about annuities.

How Does an Annuity Work

For starters, an annuity is an insurance product that pays out income. You make an investment in the annuity and then it makes payments to you, which can be a source of dependable income for your retirement.

Product Misconceptions

“A lot of folks think annuities are kind of a one-size approach, that there’s only a certain type of annuity,” says Spencer Hall, certified financial planner and managing partner of Retirement Planning Services, LLC. “In reality, the spectrum of annuities that is out there is dizzying. One of the misconceptions is people not understanding the breadth of different options.”

Annuities can be divided into two distinct categories: fixed and variable, according to brokerage and banking firm Charles Schwab.

  • Fixed annuities pay a predictable income stream
  • Variable annuities’ payments will depend on the performance of underlying investments.
  • Annuities can also be deferred or immediate, meaning they begin paying out on a future date or payments can start right away.
  • A variety of different riders can be applied to all kinds of annuities

Learning more about the types of products available can help you better plan for your retirement.

Fee Misconceptions

Many people believe all annuities come with high fees and high commissions to the broker or salesperson. While this may be true of some annuities, different types have different costs associated with them.

“A key part of the misconception is that they’re lumped in as a product that slick salespeople sell others that are very high-commission products or are very expensive products and may not be suitable for everyone,” says Hall, who is based in Knoxville, Tenn. “But you’re kind of throwing out the baby with the bathwater. There are low-cost providers out there who are providing an excellent service … and are keeping costs low.”

It can be complicated determining what kind of fees you may encounter with each product. Many companies that offer annuities recommend researching how the fee structure works before buying a product.

Fidelity Investments suggests annuity shoppers get familiar with fee types so they can ask the right questions and have a better understanding of what features they’re paying for.

Some annuity fees include insurance charges, surrender charges, investment management fees and rider charges, which vary depending on which type of annuity is chosen.

“[Annuity shoppers] should have a sense of the fees that are associated,” Hall says. “Every benefit that is given is going to have a cost — there’s no free lunch.”

When is an Annuity Right for You?

Still, many financial planners don’t choose annuities as a primary retirement income planning strategy for their clients, but rather, as a secondary tool. If annuities are used, retirees should only invest a portion of their savings, and put the rest toward other investments, says Judy McNary, of McNary Financial Planning, LLC in Colorado. In general, be cautious when investing in annuities. Get a second opinion from a financial planner or a family member, she says.

“It’s worth researching before signing,” McNary says.

Learn more about annuities to decide whether one might be a good option for your retirement planning.

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