6 Important Questions to Ask Before Buying an Annuity

Buying an annuity is an important decision that can help you both accumulate money before retirement and ensure that you have a steady flow of guaranteed income when you decide to retire.

Knowing the answers to some key questions about annuities can make you a more informed buyer and increase your comfort level with the role the product will have in your financial portfolio.

1. What Type of Annuity Do I Need?

This is the most important question when considering a purchase.

There are two broad areas that you should consider before buying an annuity contract:

• When you need the money, and
• The level of risk you are willing to take to grow your money

First, if you are interested in accumulating money for your nest egg prior to retirement, then you would buy a deferred annuity and hold on to it for many years (the accumulation period).

If, however, you are nearing or are in retirement and would like to create a steady income stream to supplement other investment income and social security, then you would either annuitize an existing deferred annuity or buy a new, immediate annuity. Among all financial products, annuities are the only product that provides a guaranteed stream of income in retirement.

The second key area is defined by the level of risk that you are comfortable with. There are three primary types of annuities when it comes to risk, fixed, variable and a hybrid of the two called a fixed-indexed annuity.

1. Fixed: These annuities offer a fixed rate of return, which means your returns will not fluctuate based on the performance of the stock market but instead feature a rate guaranteed by the insurance company.
2. Variable: Variable annuity contracts offer a variable rate of return, which means the returns will fluctuate based on the performance of the stock market. This type of annuity offers the most growth potential and the most risk.
3. Fixed-indexed: These hybrid annuities offer a rate of return that is linked to a stock market index but also guarantee a minimum interest rate return.

In some cases, especially when considering variable and fixed-indexed annuities, you may want to consult with a financial advisor to determine which version is right for you. The advisor will take into account your specific financial goals, investment horizon, and risk tolerance.

2. What is the Insurance Company's Financial Strength Rating?

An insurance company's financial strength rating is assigned by a rating agency such as A.M. Best, Fitch, Moody's, and Standard & Poor's.

The rating is the organization’s assessment of the insurer’s ability to meet its financial obligations, including paying claims and meeting annuity obligations. Ratings typically range from "A" (excellent) to "D" (poor), with some agencies using additional categories such as "AAA" (superior) and "C" (weak). These rating agencies are independent of the insurance companies and are not affiliated with any government agency.

Before buying an annuity, it is important to find out the company’s rating. You may want to start with the largest agencies, such as A.M. Best or Standard & Poor's. Ensuring that the company has a “good” rating or better can provide you with peace of mind knowing that they have a better than average ability to fulfill their obligations to you.

3. What Fees Can Be Associated With an Annuity?

There are some annuity fees to be aware of, regardless of the type of annuity you are considering. The following are some of the most common fees.

Surrender Charges

Most, but not all, annuities come with surrender periods. If you withdraw money during this period, you must pay a fee called the surrender charge. The surrender charge is part of your contract, usually 2% — 10% of the withdrawal amount.

Many insurance companies allow you to take penalty-free withdrawals of 10% or less of your annuity’s value each year. For qualifying medical conditions, you may be able to cash out your entire contract. On top of that, surrender charges are typically reduced by 1% each year.

Administrative Fees

Administrative fees are typical expenses for various low-maintenance services, such as bookkeeping, issuing annuity statements, or managing your account. Administrative fees are typically low (around .3% of your annuity value).

Rider Fees

A rider is an extra benefit that you can add to your annuity contract. Riders mitigate specific risks, such as inflation or losing too much money in investments.

Rider costs vary, usually from .25% to 1% (though they can be higher than that), and they’re deducted, monthly or annually, from your account value.

Investment Fees

With variable annuities, you invest your premiums in sub-accounts that are subject to annual investment fees. These fees can be high, sometimes as high as 3%.

Agent Commissions

When an agent sells an annuity product, they receive a proportionate amount of the sale, called their “commission.” Insurance companies pay annuity commissions directly, so you don’t have to worry about them coming out of your account. But, like fees, annuity commissions are often built into your interest rate.

The only way to get around paying an agent fee is by not working with an agent. Some companies, like Canvas Annuity, offer online purchase options that don't require an agent.

4. What is the Payout Rate for an Annuity?

With the stock market having its ups and downs, bonds are generating strong returns again, and payout rates for financial instruments like fixed annuities, whose rates are usually tied to bonds, are up significantly. This is good news if you are in the market for a payout annuity (also known as an income annuity)

As we discussed, when you buy an income annuity or annuitize an existing deferred annuity, you give an insurer a lump sum of money (single-premium), and they guarantee a payout for a period of time that you choose. You can even choose an option to receive income for life.

There are other payout options available that can help you choose based on your marital status, health, and other factors. Discuss all of these options with a financial advisor before making a decision on an income annuity.

For income annuities, the rate of return will vary by the insurance carrier issuing the product. Because these are long-term payment vehicles, the amount of the payments will depend on the length of time you choose to be paid and your gender, among other factors. But payout rates are up significantly in the current financial environment. Here is one payout annuity calculator that can help you estimate payments in retirement.

It's best to compare payout rates from different companies to find the one that offers the best value for your unique situation.

5. Are There any Death Benefits Available with an Annuity?

Most annuities feature a standard death benefit. This feature lets you pass on assets from the annuity heirs after your death. The feature may also appear as an optional rider and may have a cost related to it.

In a typical scenario, you can pay out any remaining assets to your beneficiary after you pass away. For instance, if you purchased a $500,000 annuity and it paid out $400,000 during your lifetime, the remaining $100,000 could pass on to someone else as part of the death benefit.

There are other death benefit options, including what is called a "stepped-up benefit" and "guaranteed increase." These non-traditional options typically come with costs that are reflected in smaller monthly benefits. This is another topic that you should discuss with a financial advisor before making a decision, as everyone has a unique family circumstance.

6. Can I Make Additional Contributions to an Annuity After Purchasing It?

Most deferred annuities are known as single premium deferred annuities, or SPDAs. With these products, you make a single deposit when you sign the contract and are not allowed to add additional funds during the term of the annuity.

A flexible premium deferred annuity offers a way to buy an annuity without having to pay a large lump sum premium all at once. You make one initial premium payment, then additional payments at your own pace. There are no scheduled payments. The money in the annuity grows as you make new premium payments and accumulate interest.

If purchasing an annuity with a lump sum payment isn't practical for you, a flexible premium deferred annuity may allow you to make smaller premium payments over a period of time.

Conclusion

Annuities may seem complex, but if you research and know what your goals are, the buying process can be relatively easy. Knowing what questions to ask yourself and/or your financial advisor can help.

For more complex products like variable and fixed-indexed annuities, you may want to consult with a financial adviser. For fixed annuities, the buying process is straightforward.

With Canvas Annuity, for example, you can buy a single premium deferred fixed annuity directly from the company. With annuity rates as high as 5.70%, now may be a great time to allocate some of your savings to grow money safely prior to retirement.