Learn About Annuities in Northeast Dallas

Learn about annuities from our podcast, The Rothrock 30. It’s hosted by our investment adviser representative in Northeast Dallas, Robb Rothrock.

An annuity is a contract between you and an insurance company. It is important to know how to fund an annuity, what the contractual guarantees are, and the various ways that you can get your money out of the annuity, including what, if any, penalties may apply for an early withdrawal.

Annuities can be purchased with retirement funds from an IRA, 401k, or similar retirement account, or with funds outside of a retirement account. When you purchase an annuity with retirement funds, the annuity maintains the same pre-tax status, meaning that you can move money from a retirement account to an annuity with no tax consequences.

Below we will first explore the different types of annuities, how to get money in and out of an annuity, and then we will cover some common myths and misconceptions. Before we do that, let’s look at the two primary reasons why people buy annuities in the first place.

Podcast: “Now May Be a Great Time to Look at an Annuity”

 

Lifetime Income That You Cannot Outlive

An annuity is the only financial product that can provide a lifetime income. Typically, Social Security will provide less than half of the income you will need in retirement. So where will the rest of it come from? If you have accumulated retirement savings, you will have to make sure that you can draw on these savings and that they won’t run out if you live too long. In fact, longevity risk is one of the risk factors that you face in retirement. An annuity can solve this problem.

Protected Growth

Another risk that all retirees face is sequence of returns risk. What is that? Well, when we are working and saving, we aren’t too concerned about the ups and downs of the stock market. But, as we near retirement and in the early years of retirement when we are now taking money out of our savings to supplement our Social Security, a couple of bad market years early on can blow up your retirement plan and leave you at risk of running out of money. The right type of annuity can completely eliminate this risk and still give you some participation in market upside, with no participation in market downside…in other words, a truly risk-free return. And, once you earn periodic interest in an annuity, you have now set a new floor that you can never go below. In other words, once you realize a gain, you have locked in that gain forever.

Single Premium Immediate Annuity (SPIA)

This is the simplest type of annuity where you exchange a lump sum for an immediate income stream that can be structured to last for the rest of your life, or for a contractually stated amount of time.

Single Premium Deferred Annuity (SPDA)

This is the same as a SPIA except that you defer lifetime income, instead electing to start income at a later date, usually in exchange for a guarantee that by deferring, your future income will be more than if you took income immediately.

Multi-Year Guaranteed Annuity (MYGA)

This is a very simple annuity that works much like a CD, but with a significantly higher interest rate (and also a significantly higher early withdrawal penalty). At the time you purchase the contract, your interest rate guarantee is fixed for the life of the contract, and each year you will be credited that rate, regardless of whether or not interest rates move up or down in the future. The term can be as short as one year, or for several years. Some of these annuities will allow partial penalty-free withdrawals and some won’t.

Fixed-Index Annuity (FIA)

This type of annuity offers you the opportunity to participate in some of the upside of an index that might be tied to the stock market (such as the S&P 500) but with the guarantee that if the market (or more specifically the index) goes down over time, such as from one year to the next, then you will not lose any money. These type of annuities typically give you a chance to earn more than the MYGA annuity mentioned above, but usually the surrender period (the time that you might be penalized for an early withdrawal) is longer.

Most of these types of annuities will allow up to 10% of the account value to be withdrawn in any single year, without penalty.

It is possible to find this type of annuity with no fees, or with fees, depending on the product.

Fixed-Index Annuity with an Income Rider

An Income Rider is an optional add-on (usually for a fee) that give you the opportunity to “turn on” lifetime income at a later date. The benefit of this rider is that once you turn on income, you still have not annuitized the contract, which means that if you were to pass away unexpectedly, then your designated beneficiary would receive the remaining funds, including any growth, after any withdrawals have been accounted for.

Variable Annuity

A variable annuity is actually a security product, and you can certainly lose money in such an annuity. These have also been known to have high fees, and due to these two features, we do not work with any variable annuities.

There are two ways you can fund an annuity. You can fund an annuity with a single up-front premium – this is referred to as a “Single Premium.” If you’re planning on taking payments within the first 12 months, it’s a “Single Premium Immediate Annuity”, or SPIA. Or, if you are planning on deferring payments until later, it’s a “Single Premium Deferred Annuity”, or SPDA.

You can also fund an annuity through a series of payments.  Most non-Single Premium annuities offer “Flexible”, or, Flex” funding. This means that the insurance company will accept premium payments over time.  Usually, this funding can be of varying amounts. The annuity contract specifies how and when the annuity may be funded. A typical fixed annuity requires an initial premium payment of $5,000, or $2,000 if the annuity is in an IRA.

Sooner or later you will want to get your money out of your annuity. Most annuities offer a variety of ways to take your money out at maturity, called “Settlement Options” or “Annuitization.” Here are several common Settlement Options:

Single Life – With a single life settlement option, an individual will receive a fixed payment, usually monthly, for the rest of their life. Payments end with the death of the person who is receiving payment.

Joint and Survivor Life – With this option two persons receive a single payment, usually monthly, for the rest of their life. When the one of the couple dies, the second person continues to receive the payment until that person also dies. Payments end with the death of both persons.

Period Certain – This means you can take your money out over a period of 5, 10, 15, or 20 years. The insurance company guarantees to pay out all your money, plus interest, over that period. If you die before the end of the period, your beneficiary gets what’s left in your annuity over the balance of the period.

Lump Sum – With this option you take all your money, plus any increases in the value of your annuity, out of the annuity at one time.

Only a small percentage of annuities are actually “Annuitized,” because once they are, the lump sum investment is no longer available. But you can purchase an optional “income rider” that will allow you the flexibility to turn income on and off, while still preserving the cash value build up in the contract. There are many variations of these riders and we use them often, but we won’t explore them in detail in this report.

Myth: “Once I put money onto an annuity, the insurance company has it forever and if I die early, they keep it all”

In the case of a single premium immediate annuity (SPIA) or deferred annuity (SPDA), this can be the case if you only elect to choose income for your life only. But, very few annuities like these are sold today and we rarely see the need to use this type of annuity.

The annuities we have all have a death benefit that will pass to your beneficiaries at your death, as long as your withdrawals don’t exceed your initial premium plus any gains you’ve earned.

Myth: “Annuities have high fees”

In the case of variable annuities, this can certainly be the case. But, these are actually security products and we do not work with any variable annuities. Some of the annuities we work with have fees, and some don’t. The most common fee is an “income rider” and will range from .5% to 1.25%. This type of rider allows you to turn on lifetime income without forfeiting the death benefit to your beneficiaries. But, some annuities have no-fee income riders, and sometimes you don’t need an income rider. Many of the annuities we offer have zero fees.

Myth: “I can’t get my money out of an annuity without a severe penalty”

Most annuities have a feature allowing you to withdraw up to 10% of your account value in any given year with no penalty whatsoever. Also, many annuities waive the surrender charge entirely if you become terminally ill or are confined to a nursing home.

Most annuities are bought with retirement account funds, and if you were to take all your money out at once, you’d face a huge tax bill. Think of it this way – you didn’t put all of your money into your retirement account all at once, rather you put money in one paycheck at a time, over years and years. These accounts are designed to for you to take money out the same way it went in, a bit at a time. So if you really think about it, an annuity aligns very well with a retirement account, because they are also designed for you to withdraw money over time.

And, once you’ve held an annuity past the initial surrender period, then you can roll the funds into another financial vehicle with absolutely no penalty.

Misconception: “My broker thinks an annuity is a bad idea”

Why would they say that? Is it because they know if you put your money in an annuity, then they will no longer earn fees from your account? If you really think about it, your broker loves annuities, because you are their annuity!

One of the most common things an investment broker will tell you is to not worry about market downturns because it always recovers. I would argue that when you are younger and saving money, this is generally true, but, when you are retired and withdrawing money from this account, taking funds out of an account that is also declining in value is a recipe for running out of money too soon. A successful retirement requires a completely different strategy than when you are younger, working, and saving.

Myth: “I will pay a high commission if I buy an annuity.”

Fixed annuities are insurance products and do pay commissions to the agent. The commissions can vary substantially from one product type to the other. But, you also pay fees and commissions on mutual funds and brokerage accounts. In fact, the longer you keep and IRA, 401k, 403b, or brokerage account, the more your broker makes and the more fees you pay. Sometimes these fees are not clearly disclosed, and often end up being significantly more that any commission on an annuity. Besides, you will never pay the commission – the insurance company pays the agent, not you. The main reason there is a surrender charge for early withdrawal is to cover this commission, but once you’ve held the annuity past the surrender period, then you can do what you like with the money. If you buy an annuity with no fees and hold it long enough, not only will you be protecting your money and earning interest, but you will have paid absolutely zero in fees.

Robb Rothrock is not only a licensed insurance agent, but also has a Series 65 (Investment Advisor License) which makes him a Fiduciary. He will always disclose any and all fees in an annuity and only recommend annuities that are in your best interest.