Understanding the nuances of different annuity types

Special to 318 Forum

What are annuities, and when do they make sense?

Since the financial crisis of 2008, many investors have been looking for ways to reduce risk from their portfolios. They don’t want to take another painful hit, especially if they are already retired.

That’s one reason annuities have become a more popular part of Americans’ retirement plans. They offer protection from market risks while guaranteeing a specific income level during retirement.

THE BASICS

An annuity, put simply, is a contract between you and an insurance company. You agree to make a one-time payment or a series of payments, and the insurance company agrees to pay you a certain amount of money over time. They may start paying you now or at a later date, depending on which annuity you choose.

There is tremendous flexibility in different types of annuities, though. Like any investment, you should make sure you fully understand what you will be getting and how much it’s going to cost you. Annuities aren’t offered for free and don’t fit everyone’s retirement needs, so it’s important to get a clear picture of what the annuity will do for you, what strings are attached to your money, and how your broker will be compensated.

EARLY WITHDRAWAL

With most annuities, you should be very confident you want to leave your money in them for a long period of time, because they can charge hefty fees for withdrawing your money early.

Not only will there be potential charges written into the annuity contract for pulling your money out too soon, but you could also face tax ramifications if withdrawals are taxed as ordinary income instead of capital gains like traditional stock-based investments. The overall hit can be huge.

TYPES OF ANNUITIES

Annuities generally fall into three categories: indexed, fixed and variable.

Indexed annuities will pay you a varying amount of money based on how well a certain stock market index performs. It may be based on the Dow Jones Industrial index, for example, or the Standard and Poor’s 500 index. They will often have a minimum payment that you will receive regardless of market performance and a higher payment when the market races upward.

Fixed annuities, as their name suggests, pay you a fixed amount of money every month. Some will be for a certain period of time, such as 20 years, while others will be for an indefinite period of time, such as the lifetime of you or your spouse.

Variable annuities, which are regulated by the Securities and Exchange Commission, are securities that are based on investment options that you make. You can choose to invest in different mutual funds, for example, and the size of your payments will vary with how well your investments performed while they were growing.

ASK QUESTIONS

No matter what type of annuity you consider, always ask lots of questions. You need to fully understand the annuity contract you’re entering into, including all the risks and associated fees that come with them.

It’s also a good idea not to make your investment decisions in a vacuum. Talk to a variety of financial planners, investment advisors and tax professionals to find the right products to meet your needs.