What You Need to Know
- Variable annuities offer owners a chance to get higher returns.
- Fixed annuities tend to have lower levels of risk and lower fees.
- For many clients, a fixed annuity can be a good alternative to a bond fund.
Clients who have attempted their own research on individual annuities may have encountered conflicting and sometimes negative information.
With so much confusion surrounding annuities and the contrasts between differing types, it can be difficult to help clients understand whether they are the right addition to their retirement portfolio. However, with a little context and explanation, individual annuities can be demystified, and clients can make more informed decisions.
As an advisor, you most likely know that an annuity is an insurance contract that is created when an individual makes a payment (or a series of payments) called premium(s), which will generally grow at a set rate and in a tax-deferred status. In return, the insurer offers crediting options for accumulation or periodic payments back to the individual.
Clients, however, may not have this knowledge — by providing a basic definition like this, you can help frame the conversation for those trying to understand how annuities work at the most basic level. From there, you can expand on the different types of individual annuities.
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Two Main Types of Individual Annuities
Once your clients have a general understanding of what an individual annuity is, it’s important to distinguish between the two main types, fixed and variable, to better help them evaluate which option might be right for them.
A fixed annuity guarantees to pay a specified interest rate that is based on the current interest rate environment, and many guarantee no loss of the principal outlay. The initial rate is guaranteed for one or more years, and subsequent renewal rates are guaranteed to stay above a specified minimum rate. Because it provides several guarantees, a fixed annuity is viewed as a conservative financial product.
A variable annuity offers earnings and income payments that fluctuate with the performance of specific investment funds. While variable annuities have the potential to provide higher returns, they differ from fixed products because the policyowner bears the investment risk and potential loss of principal. As these products are more complex and have more risk associated with them, the advisor who sells this annuity must also be licensed to sell securities.
Fixed vs. Variable: The Key Differences
Fixed annuities have many benefits that make them attractive additions to any retirement portfolio. As mentioned previously, many fixed annuities provide protection of the principal. This means that regardless of how the financial market performs, a fixed annuity owner will never lose their premium payments so long as the annuity carrier remains solvent. This benefit makes fixed annuities a safe choice for those who aren’t comfortable with or can’t afford to take as many risks with their money. This is particularly appealing to those approaching retirement.