June is National Annuity Awareness Month, an effort launched by the insurance industry to promote education about this complex and often misunderstood investment tool. Not only are annuities complex, but they are also the subject of a great deal of misinformation, and sometimes biased reporting, in the financial media.

In truth, an annuity can be an efficient and reliable source of retirement income for many investors. But there are so many different types of annuities offering so many different features, it’s important to work with a professional to choose just the right option for your needs, goals, and situation.

Like any financial product, annuities are also impacted in various ways by the financial markets. Understanding those impacts is important when it comes to choosing an annuity and when considering potential changes or upgrades to your investment down the road.

Here are some basic facts about annuities, along with some timely information about how they’re faring in today’s market.

Annuity Basics

At its core, an annuity is a contract between you and an insurance company that allows you to contribute money to a tax-deferred account. In return, you can get regular payments from the account as income.

There are three basic types of annuities to choose from, each with different features and risk levels.

1. Fixed Annuity (lowest risk): With a fixed annuity, you agree to deposit a lump sum, or make a series of payments, and the issuer agrees to pay you a guaranteed rate of interest over a set period. It is a contractual investment that works much like many individual bonds.
2. Indexed Annuity (moderate risk): An indexed annuity earns interest based on the performance of an underlying market benchmark, like the S&P 500, and is subject to interest rate caps. It can allow you to partially benefit from upturns in the index, with a limit to your downside risk.
3. Variable Annuity (highest risk): A variable annuity places your money in investments you select from a list made available by the issuer. It does not offer guaranteed returns and may lose or gain value depending on the performance of the investments.

Immediate or Deferred

Whether your annuity starts generating monthly or annual income payments right away or at a set date in the future depends on whether it is an immediate annuity (right away) or deferred (in the future). Immediate annuities are the most popular, but the deferred option (also known as a Longevity Annuity) is growing in popularity as lifespans continue to increase and investors seek to better ensure they’ll have sufficient and reliable income in their 80s and 90s.

Potential Pros of Annuities

• Guaranteed Income: Some annuities offer lifetime income, providing peace of mind and ensuring a less stressful retirement.
• Tax Deferral: Earnings grow tax-deferred until withdrawal.
• Customizable: Many features of an annuity can be tailored to your specific needs.
• No Contribution Limits: This can help if you are near retirement and behind on your savings.

Potential Cons

• Fees: Some annuities have high costs that can eat into returns.
• Complexity: Some contracts are hard to understand, with fine print that matters.
• Lack of Liquidity: Annuities often have surrender periods, meaning penalties for early withdrawals.

Key Considerations in Today’s Market

Again, annuities are impacted in various ways by the financial markets, so here are some of the impacts and potential impacts to keep in mind when looking for an annuity in today’s market.

• Interest Rate Environment: Elevated rates can mean better returns on fixed and immediate annuities, but they can also influence caps and participation rates on indexed products.
• Fees & Riders: Understanding costs (administrative, mortality, management) and optional guarantees is vital, especially in variable annuities.
• Liquidity & Terms: Look closely at surrender charges, free withdrawal allowances, and penalties for early access.
• Inflation Protection: Riders or annual increases tied to inflation can help maintain your purchasing power over time.
• Financial Strength: Choose insurers with strong AM Best or Moody’s ratings to ensure the annuity’s terms and guarantees hold up.

Summary

Once again, annuities can be powerful retirement income tools, but only when matched with your specific needs, goals, and broader retirement income strategy. Before buying an annuity, be sure to work with an Income Specialist to understand how the product works, what it costs, when the best time is to buy (based on market conditions), and whether it is really the annuity that best fits your retirement income strategy!