How to Evaluate an Annuity Contract

Annuities are long-term financial products that help you accumulate and distribute money during your lifetime. Choosing the right annuity product for your unique situation, risk tolerance and goals can be confusing. Let's review some steps you can take to carefully choose the right product for you!

Consider Your Goals for Purchasing an Annuity

One effective way to decide whether an annuity has a place in your retirement plan and, if so, which version you should buy, is to determine what goal you want to achieve.

For instance, if you are currently working and your goal is to grow money for the long term, you might choose an annuity that helps you accumulate money prior to retirement. These are called deferred annuities.

If, however, you are near, or in retirement, you may want to choose an annuity that helps you distribute money effectively to create a personal pension. These are known as immediate or income annuities. Another factor in your annuity purchase is the source of funds you will use to purchase the product.

Determine if it is Qualified or Non-Qualified

If you are purchasing an annuity using funds from a checking account, savings account, CD, or another source where you have already paid taxes on the money, then the funds are considered "non-qualified" funds.

One key benefit of non-qualified annuities is that there is no government-mandated contribution limit, unlike other types of retirement savings vehicles such as an IRA or 401(k). Another big plus is that these funds are not subject to government required minimum distribution (RMD) rules. This means that you won't be forced to distribute this money starting at age 72.

If you are using money that currently sits in tax-deferred accounts like IRAs, then the rules are different.

Because annuities are so popular, some people buy them with money currently held within a retirement account. This money is considered “qualified money” because it is held in an IRS qualified retirement account. Qualified retirement accounts include traditional IRA, 401(k), 403(b), 457, SEP-IRA, and similar accounts.

When you purchase an annuity with non-qualified funds, you receive special IRS treatment that the IRS normally reserves for qualified accounts:

• Tax-deferred growth. Qualified retirement accounts already offer tax-deferred growth, so there’s no additional tax benefit when you use qualified funds to buy the product.
• No contribution limits. Even though annuities do not have contribution limits, a qualified annuity is still subject to RMD rules.
• Required withdrawals. Qualified withdrawal requirements are determined by the retirement account. Annuity RMDs are required once you reach age 72. Non-qualified annuities do not have any withdrawal requirements until the policy matures.
• Tax-advantaged withdrawals. When you take annuity payments from an annuity funded with qualified money, every dollar withdrawn is considered taxable income. Both the principal and earnings withdrawn are subject to income taxes. With non-qualified annuities, only the earnings are subject to tax.

Determine the Type of Annuity Best Suited to Your Goals

Having set the table for your exploration of annuities, let's take a look at options depending on your financial situation and goals when purchasing the annuity.

Goal: I am in my working years and want to accumulate money and defer taxes on the gains.

For people who are not yet near or in retirement, deferred annuities are a powerful way to plan for financial security well ahead of retirement and defer taxes until you withdraw the money. Here are the most popular choices for tax-deferred annuities to consider during the accumulation phase of the annuity:

• Fixed Annuities: Also commonly referred to as declared rate annuities, this is an annuity contract that allows you to grow your money at a fixed rate. Fixed annuities are great products for people who want to avoid the ups and downs of the stock market.
• Variable Annuities: An annuity contract where the interest rate you receive is variable depending on the investment options you choose. This is a product that is best purchased with an experienced financial advisor. You can lose money with this type of annuity but you may also earn more than with a fixed or fixed-indexed annuity.
• Fixed-Indexed Annuities: A hybrid annuity contract with components of both fixed and variable annuities. The interest rate depends on the performance of a chosen index but with a fixed minimum crediting rate which guarantees you won’t lose anything if your index does not perform well, although you may not have any gains either.

Goal: I am in or near retirement and I want to create a stream of retirement income as part of my overall plan.

For people looking to use an annuity to create a foundational stream of monthly income upon which to layer other investments, there are a few choices:

• Single Premium Immediate Annuities: Sometimes called an instant annuity, this type of annuity is where the income stream begins soon after you buy it. It can be a great way for retirees to supplement the income received from social security and even ensure income for the rest of your life.
• Deferred Income Annuities: A deferred income annuity (DIA) allows you to use a lump sum payment or multiple purchases to receive a guaranteed retirement paycheck, but the annuitant receives payments at a future date of their choosing, typically ranging from 13 months to 40 years from the initial purchase.
• Deferred Annuity with annuitization options: The main types of deferred annuity are listed above (fixed, variable, fixed indexed). Deferred annuities build value over time and, when you’re ready, you can annuitize. Annuitizing simply means turning your annuity into a stream of income payments. Annuities have different annuitization options. The income you receive from your annuity will depend on your age, gender, chosen time period and the interest rate declared by the company.
• Lifetime Withdrawal Benefit Rider: While this isn’t a type of annuity contract, it is a rider that some companies offer along with different types of annuities. This rider can be a good option for people that know they want lifetime income because it can potentially provide a larger stream of income than the annuity would on its own and continues to payout even after the annuity’s account value drops to zero.

Verify Policy Specifics with the Insurance Company

Annuities are insurance products that can come with many bells and whistles making it critically important that you review the details of the annuity policy before you purchase. Ask yourself some key questions when reviewing the contract detail:

• Is this product designed for the accumulation or distribution of my money (or both)?
• Are the rates of return guaranteed or variable?
• If this is an income annuity, what will the payments on my annuity payout be and how long are they guaranteed for?
• Is there a death benefit available for my heirs?
• What are the annual fees, if any?

Review the Expected Future Return of the Annuity

Knowing the future value of your annuity can be useful when planning for your retirement and assembling a portfolio that ensures you can be comfortable in retirement.

Once you know how much money your annuity payments may be worth, you can make spending and lifestyle decisions based on your expected income.

Of course, the actual payout depends on many factors, including the period of time over which you will receive the monthly payments. For example, you can choose lifetime income payments or a period certain option that provides guaranteed income over a period of time specified by you.

The future value of an annuity is the total value of annuity payments at a specific point in the future. The future value of an annuity calculation shows the total value of a collection of payments at a chosen date in the future, based on a given rate of return. This is different from the present value of an annuity calculation, which gives you the current value of future annuity payments.

Compare the Annuity's Expected Return to Its Annual Fees

It is important to keep an eye on fees when purchasing an annuity or calculating annuity income in retirement. Fees, especially when considering a variable annuity product or a product with multiple riders, can eat into returns.

These fees can be as high as 3% per year, reducing the amount of money that you may have been expecting, or even using in a budget. Make sure to ask your financial advisor or insurance agent about fees and how they can eat into your expectations of income.

Review the Annuity's Terms to See if It Allows for Partial Withdrawals

When you buy a deferred annuity prior to retirement, you are making a long-term commitment and accept that you will have limited liquidity in the short term. The insurance company that issues the annuity assesses surrender charges if you try to withdraw funds prior to the end of the surrender charge period (usually 5-10 years).

The good news is that some annuity providers allow a percentage of your annuity value to be withdrawn each year, if needed, without penalties. Canvas annuity, for instance, allows the owner to withdraw up to 10% each year, starting in year one, without surrender charges.

Research the Annuity Company's Credit Rating

There are several factors to consider when choosing an annuity provider. Certainly the product features need to match your goals, but one important consideration is the financial strength rating of the life insurance company that issues the contract.

Annuity companies receive rating assessments from 3rd party agencies on the creditworthiness and financial strength of the company. There are four large credit rating agencies, including A.M. Best, Fitch, Moody's Investors Services, and Standard and Poor's.

The company's ability to meet its future financial obligations, its cash reserve, and the company's ability to manage risk when issuing policies are all considered when the rating agency issues a rating.

Purchasing an Annuity with Canvas

For people looking to accumulate money safely and reap strong returns, fixed annuities can be a solid solution.

Annuities from Canvas are unique because they offer the ability to purchase a fixed annuity at very competitive interest rates directly from the company and 100% online if you choose. And Canvas also provides a learning center that can answer questions that may come up when evaluating your annuity purchase options.

Contact one of our licensed representatives today to learn more.