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March 8, 2017

5 Things to Know Before Buying Deferred Fixed Annuities

Annuities are big business. Why? Because annuities provide retirees with a different type of protection. Baby boomers are retiring at record numbers, but along with higher levels of good health and longer life expectancies comes the challenge of having enough money to live well throughout retirement. Mutual fund accounts and traditional stock market investments can't do what a deferred fixed annuity can and that's protect retirees from outliving their money. Of course, the increased protection comes with restrictions, fees and costs.

Here's what you need to know before you invest in a deferred fixed annuity.

1. How Much Does It Cost?

Typically, annuities cost more than mutual funds. Look beyond the sales pitch and contract guarantee and into the fees charged before investing. Fees charged generally include an administrative fee, mortality and expense fees and fees for optional benefits.

Optional benefits may include a guaranteed minimum return or sustainable lifetime withdrawal. In addition, other fees may include surrender or withdrawal charges, contract fees, transactions fee, premium tax and premium charge percentage fees.

Annuity formulas are complicated, but after you gather all of the fees and costs involved, use an online deferred fixed annuity calculator to compare plans, determine if a specific annuity is the right fit and give you a better understanding of what annuities are all about.

You'll need the following information:

  • Starting principal 
  • Annual growth rate 
  • Annual fee and expense rate  
  • Growth period or years to retirement  
  • Withdrawal period or estimated number of retirement years  
  • Annual growth rate during withdrawal period

Arming yourself with real numbers before you purchase an annuity is the only way to determine if a product fits your individual needs.

2. What's the Interest Rate?

Your fixed rate deferred annuity contract should explicitly state the accumulation period interest rate. Your provider fixes the rate, but it's up to you to ask your provider how the rate is set.

3. What are the Contract Benefits?

Different companies offer different payout options. For example, the Life Only option pays for the rest of your life. The Life Annuity with Period Certain pays during your lifetime and a set number of years after. Another option is Joint and Survivor, which pays as long as you live, and if you die before your beneficiary, pays for the life of your beneficiary.

Also look into what happens to the money if you die before your benefits begin. Some providers pay a death benefit to your beneficiary if that happens. You and your beneficiaries should carefully go over the contract before you decide to buy.

4. What About Taxes?

Taxes on annuities fall under federal law. Income tax on annuities may be deferred as long as it stays in the annuity.

The advantage to tax-deferment is when you retire, you'll likely fall into a lower income bracket and pay less tax when you receive the money. States typically follow federal law when it comes to annuities, but due to the differences in state law and possible changes in federal law, speak with a tax adviser about your personal situation.

5. Is a Fixed Deferred Annuity Right for Me?

Before investing in a fixed deferred annuity, think about your goals. What is your "risk" quotient? Figure out how much money you'll have for retirement if you don't buy an annuity. How much will you get from Social Security? That certainly won't be enough. What about a company pension or retirement plan? If you pay into a deferred fixed annuity and there is a financial emergency, can you get the money out? What are the penalties if you do?

There are multiple resources for you to gather information and make an informed decision. Study investment books, research online sources and work with a certified professional financial adviser to find out if a fixed deferred annuity is right for you.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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