So many new clients come to me already owning an annuity or several annuities, and they do not understand them or know what types of fees are in them. I went back through my e-mails to clients and looked through the types of questions I get about annuities, and thought I would answer some of them here by explaining some of the concepts around annuities.
An annuity is a product offered through insurance companies. It is tax-deferred, which means the income and earnings from the investment stay in the account and are not reported on your tax return each year. That is the good news. The bad news is that when you take the money out of the account, it is taxed at your income tax rate, which could actually be at a higher rate than the rate you would have paid if you hadn’t had your money invested in an annuity, depending on the type of annuity you have. However, the tax deferral is a nice benefit.
Fixed Annuity
With a fixed annuity, you get a specific interest rate for a specific time period. Sometimes you will get a higher rate for the first year and then a lower rate for the remaining years, but you know this when you make your initial purchase.
Variable Annuity
A variable annuity offers you the opportunity to invest in mutual funds. There are annuities that invest in multiple fund families, including index fund families.
Death Benefit
This is an insurance product, so one feature, or “insurance rider” that some of these products have is something called a Death Benefit. Sometimes the Death Benefit value can be more than the Account Value. Each product’s Death Benefit works differently. Sometimes it is as simple as saying the Death Benefit is the greater of the current market value or what you invest minus withdrawals. Or it might have a Step Up feature. For example, each year on the anniversary of the purchase date, the value is recorded, and the highest annual value or current market value is the Death Benefit if you pass away.
1035 exchange
One nice benefit to this type of product is that you are allowed to move from one insurance company to another without any tax consequences. Doing this is called a 1035 exchange (that is, the IRS name for the procedure of moving the money; it seems like they put code numbers in the names of all of their procedures). If you cashed the money in, you would have to pay taxes on the gains. If you just move it to another annuity, then you can continue to defer the taxes.
Fees
When looking at annuities, be sure to compare fees. Fees are quoted in percentages. It is extremely important to convert the percentages to actual dollars based on the amount you are investing because when you do that, you can sometimes see thousands of dollars of difference in fees between two annuities that, when just looking at percentages, seem to be pretty similar in fee structure. I would always rather see my clients with that money in their account rather than give it to an insurance company unnecessarily.
Surrender charges
A surrender charge is a fee you pay the insurance company if you take your money out in the first few years after you have had the annuity. A seven-year surrender charge schedule is very common; for example, the first year surrender charge would be 6%, the second year would be 5%, and so on until the surrender charge went away. You might be surprised to know that there are annuities that do not have surrender charges! So if you have an annuity and you are in the position of having to decide what to do with it, you can 1035 exchange it to an annuity that does not have a surrender charge. Most people are not aware of that.
IRA annuity
If you have an annuity that is an IRA, you can always move it directly to an IRA, and forgo the extra layer of fees that you find in an annuity. Things to consider before doing that: 1) Are there surrender charges? 2) Is the death benefit greater than the current value of the account?
Learn more about your annuity by reading the statement and the prospectus. If you don’t have the prospectus, many of them can be found online by Googleing the product name. If that does not work, give the customer service department a call; they will be happy to email or mail you a copy of the prospectus, which has the fee and investment information.
Michele Clark
Michele has more than 25 years experience in financial services and has developed a specialization in working with people who are starting to seriously think about their retirement or who are retired and facing all of the complex planning issues one faces during this time.
She works with clients to coordinate decisions around investments, retirement accounts, Social Security, funding health care, tax planning, cash-flow, maximizing employer benefits, charitable gifting strategies and estate planning.
Before joining Acropolis Investment Management, Michele was the founder and managing principal of Clark Hourly Financial Planning and Investment Management for nearly nine years with an additional sixteen years at banks and investment firms.
Michele has been quoted in such online and print media outlets as The Wall Street Journal, Money Magazine, USA Today, Market Watch, US News & World Report, CNBC.com, AARP, St. Louis Post Dispatch, Fox Business, Forbes, Los Angeles Times, Financial Planning Magazine, St. Louis Public Radio, Yahoo Finance, St. Louis Magazine, and others.
Michele earned her B.A. from Purdue University. She is a CERTIFIED FINANCIAL PLANNER® practitioner, obtained the Chartered Retirement Planning Counselor (CRPC®) designation from the College for Financial Planning, and is a NAPFA Registered Investment Advisor.
Michele has volunteered her time for financial literacy outreach at Financial Planning Days, Money Smart Week, Habitat for Humanity and others.
Michele has served on the Board of Directors of the Financial Planning Association of Greater St. Louis since January 2014 and is Past President and currently serving as Chair of the Board.