Three Key Misconceptions About Annuities Demystified

A recent study showed that most people don’t understand three key features of annuity products.

The most misunderstood features are:

• Using retirement funds to purchase annuities
• The safety of annuities
• The ability of annuities to provide lifetime income

According to research organization LIMRA and their Secure Retirement Institute® (SRI), only 1 in 4 consumers correctly answered at least 7 out of 10 annuity-related questions. In addition, more than 40% answered “not sure” to each of the 10 questions.

The consumers who fared best in the survey? Current owners of the product.

“Our study revealed annuity owners go to the head of the class when it comes to understanding how annuities work,” said Matt Drinkwater, corporate vice president at SRI. “Almost 6 in 10 annuity owners achieved a high score on the annuity quiz, compared with just 21% of those who don’t own an annuity. Twice as many annuity owners view the products positively, compared to non-owners (83% to 41%).”

Misunderstanding the key benefits of annuities can cause people to miss out on features that can be very useful as you build out a sound retirement plan. Foremost among these features is the fact that annuities are the only products that can provide guaranteed income for life. Let’s take a look at three key features that are the least understood.

The Three Least Understood Annuity Features

1. Buying Annuities with Workplace Savings

Based on the quiz, only 1 in 4 consumers understood that annuities could be purchased with money saved in workplace retirement plans, such as 401(k) and 403(b) plans (known as qualified money).

This is important to know since about 55% of working Americans participate in a 401k plan.

There comes a time when many of these people will make decisions regarding how to use this money in retirement. And one way to leverage part of your 401k money is to turn it into a guaranteed source of income. Annuities are the only product that offers this guaranteed income feature.

More than half of fixed annuity purchases in 2021 were funded with money from retirement plans. Just think what that percentage might be if more people knew that they could use retirement plan money for annuity purchases!

These so-called qualified annuities are subject to the required minimum distribution (RMD) rules that apply to traditional 401(k)s and IRAs. RMD rules say you must begin taking minimum distribution of this money at age 72.

With non-qualified annuity payouts, the principal is tax-free, and the earnings are taxable. Qualified annuity payouts, however, are entirely taxable because it’s money you’ve never paid taxes on. The money is taxed based on the same tax rules as the plan used to fund the account.

For example, if you fund a qualified annuity with money from an IRA or a traditional 401(k), the IRS taxes it like ordinary income when you make withdrawals.

Like 401(k)s and IRAs, the minimum age threshold to make qualified withdrawals is 59½. Money withdrawn before this age will incur IRS penalties.

2. Safety of Principal and Growth

71% of quiz participants thought that they would lose money if the insurance company that they purchased the annuity from went out of business.

While it is true that CDs and savings accounts are insured by the FDIC, and an organization called FINRA keeps an eye on investment companies, annuities are backed by the financial stability of the insurance companies who issue them.

That’s why it is important to understand the financial strength of the insurance company that issues the annuity before you buy one. Every insurance company is rated by rating agencies that assess the insurer’s ability to pay obligations. A.M. Best is one of these rating agencies. In general, you will want to do business with companies that have a “good” or better likelihood of meeting their financial obligations (a rating of B++ or better).

In terms of safety of growth, annuities that offer fixed returns and guaranteed minimum interest rates are a good choice. Fixed annuities and fixed indexed annuities offer these features.

Finally, it’s probably a good idea to spread money among several insurance companies with good ratings. This is added assurance that your money will be safe.

3. Guaranteed Income in Retirement

Amazingly, almost 80% of participants said that they were not aware that annuities are the only financial product that can create guaranteed income that you cannot outlive.

It’s amazing because this is one of the core benefits of the product!

There are two primary ways to create guaranteed income with annuities:

• “Annuitize” an existing annuity product, turning a lump sum into a stream of income
• Buy an “immediate annuity” with either qualified or not qualified money. You sign a contract telling the insurance company when and for how long you want guaranteed income.

Annuity companies offer payout options that you can’t outlive and include:

• Single-life (also called “straight life” or “life only”). This option provides you with monthly payments until you die. When you die, payments stop, and any money left in the annuity account is kept by the insurance company.

• Life annuity with period certain. This option provides you with income for the rest of your life. It also has a feature where, if you die before the “certain period” (such as 10 years) is over, any remaining money in your annuity balance will be passed on to a beneficiary.
• Joint and survivor. This option provides both you and one other person — usually a spouse — with regular income until both of you die. It guarantees that you will both have an income as long as either of you is living.

Misconceptions Clarified!

Annuities can be valuable additions to your overall retirement plan. To review:

• You can use your retirement plan funds to buy a tax-deferred or immediate annuity.
• The insurer’s financial strength provides a level of safety when purchasing annuities, and fixed annuities guarantee a minimum rate of return.
• Annuities are the only financial product that can guarantee a level of income that you cannot outlive.

Annuities can be a valuable addition to your overall retirement savings and distribution plan. It’s always a good idea to diversify retirement planning products among different risk classes like CDs, savings accounts, stocks, bonds, and annuities.

If you want a conservative fixed annuity that currently provides an industry-leading rate of return, check out Canvas annuities. With Canvas, you can buy online or over the phone with the help of a friendly sales consultant.