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Clarification of Some Important Annuity Questions

In preparation for last month’s IMO Summit, the National Association for Fixed Annuities (NAFA) released a paper with important information about annuity products.  This information is not only important for advisors, but for consumers as well.  In one of the first summaries of NAFA’s information, Daniel Williams of Life Health Pro offered “5 answers every investor needs to know about annuities.”  The information is meant strictly to separate annuity fact from fiction and answer some basic questions.

First of all, many people wonder what kind of returns they can get from annuities.  Variable annuities actually do earn returns.  These returns are based on how your investment portfolios perform over the duration of your annuity contract.  You can allocate your money in a variety of these different investments, or subaccounts.  If the subaccount value increases, you receive a return.  If the value does not increase, you do not receive a return.  Returns are not typically guaranteed with variable annuities.  Fixed annuities, on the other hand, do not actually earn returns at all.  Fixed annuity products guarantee an interest rate, which is not based upon stock market returns.  Traditional fixed annuities guarantee an interest rate based on the insurance company’s earnings, while indexed annuities base their returns on the performance of a market index.  No matter which type of fixed annuity you choose, you are guaranteed not to lose money even if the markets do.

Another concern that people have is in regards to indexed annuities and whether they limit the amount of interest that you can earn.  Interest is calculated in a different way than it is with traditional fixed annuities.  It is true that you don’t earn the entire value of any positive gains in your index.  Insurance companies have to place caps and participation rates on indexed annuities to make up for the guarantees that you receive with these products.  When the economy is strong, caps and rates are usually higher.  When the markets are down, insurance companies typically lower these caps and rates.  This flexibility is beneficial to consumers as well as the insurance companies.  It allows consumers to maintain generous guarantees and to avoid losses when indexes are down.  NAFA recommends the academic paper “Real World Index Annuity Returns” to see examples of indexed annuity performance.

Expenses and fees are a large concern when it comes to annuity products.  NAFA stresses that you must separate variable and fixed annuities when considering expenses.  Fixed annuities have surrender charges that occur if you take your money out before the contract allows or take out more than your fixed payments before the surrender charge period is up.  Additional riders that you add to your annuity have charges, but these and all charges have to be disclosed upon purchase.  Every annuity product also comes with a “free look period”, allowing you to get your money back if you change your mind about the annuity in that time frame.  Investments do not have such an advantage.

Have you ever wondered why insurance companies impose surrender charges?  If so, you are not alone.  Insurance companies have a lot of expenses, both related to the annuity products and to running their business in general.  All of the guarantees, protection and income offered with annuities come at a cost.  So insurance companies invest your money in hopes to achieve returns.  If they take out their investments too soon, they could actually lose money.  Surrender charges help to protect the insurance company offering annuities and this is important for consumers too.  This helps ensure the best interest rates and annuity benefits for consumers purchasing from the insurance companies.

There is a lot of confusion when it comes to income riders.  Some consumers worry that these riders are actually only worthwhile if the annuity doesn’t perform well or that they have to annuitize to get benefits.  NAFA points out that variable and fixed annuities have different income stream calculations.  If you have a variable annuity, your income stream could go up or down based on the performance of your subaccounts.  Fixed indexed annuities typically guarantee a minimum income level, which has the potential to increase.  They do not require annuitization of the income rider either.  Fixed annuities offer GLWB riders that guarantee you income for as long as you live.  Income riders and annuitization have one big difference.  When you annuitize, you have converted your annuity to an income stream of payments.  You still own and control your annuity with an income rider.

Ask specific questions related to any annuity product that you have interest in purchasing.  These five annuity answers should help clear up some of the basics so that consumers can be more informed going into an annuity contract.

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