Previously, we discussed fixed index annuity rider interest and how it may be far more important to understand how much income I can take out of my annuity than the amount of interest I am being credited. In addition to understanding annuity interest for this type of annuity, clients need to understand the difference between the different types of annuities.
In other words, what is the actual structure of the annuity itself. Commonly, there are now four different types of deferred annuities that make up the vast majority of contracts sold today.
1. Fixed annuity: A fixed annuity is the simplest form of annuity. The insurance company pays you a fixed or stated rate of interest for a set duration of time. Think of it as an insurance company version of a CD. The main differences between a CD and a fixed annuity is tax deferral unlike a non-IRA CD and a lack of FDIC insurance. Typically, interest rates in a fixed annuity are higher than they are in a bank CD all things being equal. You pick the length of time, and the insurer credits a fixed amount of interest based on the length of time you choose. Once the time period is up, you are free to do whatever you want with the money. Understand that while the tax deferral can be a big plus, if you cash out an annuity, all of the interest comes out first and is taxed as ordinary income, then your principal is returned. If you roll it over to another annuity, the tax continues to be deferred.
2. Fixed index annuity: Unlike a fixed annuity, a fixed index annuity doesn’t promise you a fixed rate of return, but rather it credits your interest based on a market like index. It could be a simple as the S&P 500 or as complex as custom made volatility indexes. The appeal is that your principal is typically protected in exchange for a limited upside return. Typically, you would get a cap on the amount of interest you can earn, or a participation percentage of the index itself, though these can vary.
3. Variable annuity: These annuities are designed to allow you to make the most amount of potential interest by letting you invest the funds into subaccounts that are similar to mutual funds. There is typically no limit to the amount of interest you can earn. The downside however is that there is no limit to the amount you can lose either should the market go down. One of the ways variable annuity contracts try to limit your exposure to potential losses is to add different riders to them in order to protect some or all of the principal or future income. The downside is that all of these riders aren’t free. The cost for each type can be very expensive. This is why annuities have typically been associated with high fees. While fixed or fixed index products may have no implicit fees, variable products can cost anywhere from a few tenths of a percent all the way up to around 4%. Remember, fees like taxes are a drag on performance.
4. Hybrid variable annuity: These are the newest version of variable annuities. While they are built as a variable annuity, the interest they credit is more like a fixed index annuity. They typically offer larger upside potential than a fixed index annuity, but in exchange, you have to be willing to accept some amount of downside risk which is typically limited to a certain percentage, etc. I have found these to be the most popular among current annuity buyers because they offer features of both a fixed index annuity as well as a variable annuity.
Regardless of the type of annuity you buy, you first need to understand if an annuity is right for you before buying any annuity. Annuities can be great for the right buyer and really bad for the wrong buyer.
Fixed index annuities are not a direct investment in the stock market. They are long term insurance products with guarantees backed by the issuing company. They provide the potential for interest to be credited based in part on the performance of specific indices, without the risk of loss of premium due to market downturns or fluctuation. Fixed index annuities are designed for long term investors. These annuities do not participate directly in any stock or equity investments. You aren’t buying shares of stock or an index. Dividends paid on the stocks on which the indexes are based don’t increase your annuity earnings. Interest crediting may be based on one or more different methodologies. Please read the product prospectus for details. If you take money from your annuity early, you may lose some or all of your credited interest. If you take out all (a full surrender) or part (a partial surrender) of the money, you also may have to pay a surrender charge. The amount of the charge depends on how long you’ve had the annuity and how much you withdraw. They may not be appropriate for all clients.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures.