Quiz: How Well Do You Know Annuities?

b. No

While money held in an annuity contract can be accessed by clients, they will owe taxes on gains inside the contract. Gains are assumed to be the first money to be withdrawn in the case of a partial withdrawal. If the client is younger than 59.5, the withdrawal will be subject to a 10% penalty.

Money held in a qualified annuity inside an individual retirement account, 401(k) or other retirement plan will be subject to the withdrawal rules associated with that plan.

If a client is likely to need this money before retirement, then an annuity is probably not the best option.

Should annuities be used regardless of clients’ other sources of retirement income?

a. Yes

b. No

b. No

All sources of retirement income available to a client should be considered. For example, if a client has a solid pension from an employer and will also receive Social Security benefits, an annuity may not be needed.

On the other hand, an annuity can provide an excellent source of guaranteed income to supplement IRAs, 401(k)s and taxable investments. The right annuity can serve the role that pensions used to serve for many.

Does the type of annuity chosen for a particular client matter?

a. Yes

b. No

a. Yes

Different types of annuities have different attributes that may or may not best serve a client’s needs.

Each situation is different. For example, deferred annuities, including qualified longevity annuity contracts inside a retirement plan, can be used to generate guaranteed income later in retirement to help ensure that clients don’t run out of money. An immediate annuity can be used to generate an income stream now or within the next year for a newly retired client.

A fixed annuity provides the certainty of a fixed rate at which the funds inside the contract will grow. With interest rates at current levels, many experts say now is a good time to consider a fixed annuity. Variable annuities provide an opportunity for growth but can also lose money during the accumulation period.

Are annuity expenses a relevant factor to consider in choosing the best annuity?

a. Yes

b. No

a. Yes

Annuities with higher fees and expenses will invariably offer a lower overall return for contract holders compared with similar annuities featuring lower expenses. Unlike with mutual funds and exchange-traded funds, the fees and expenses associated with an annuity can be difficult for clients and sometimes even for advisors to determine. These expenses can include mortality costs, commissions, administrative fees and, in some cases, investment expenses.

In reviewing annuities, advisors need to help clients determine the optimal balance between an annuity’s expenses and the overall benefits the contract can provide. The high cost of some annuities is a topic that many clients may have seen covered by the financial media; don’t be surprised if they ask about this.

Can annuities be customized to better fit a client’s specific needs?

a. Yes

b. No

a. Yes

In many cases, annuity contracts allow for a degree of customization through the use of annuity riders.

Examples of riders include a minimum living benefit covering the level of income received by the contract holder, guaranteed minimum income benefits that set a floor on annuity payouts, death benefit riders, inflation protection riders, disability income riders and long-term care riders.

Riders come with costs, and advisors must help clients weigh that cost versus the benefit provided to determine if a particular rider is worthwhile.

Do annuities offer downside protection against declines in the stock and bond markets?

a. Yes

b. No

a. Yes

In some cases, depending upon the annuity contract.

For example, fixed annuities offer a guaranteed rate of return that is not affected by a market decline. Some contracts, such as fixed indexed annuities, have a floor on the level of loss that the contract can incur during the accumulation phase.

An immediate annuity is one of the safest types for clients. These are fixed annuities with a guaranteed rate that are annuitized within a year of purchasing the contract. Fixed deferred annuities offer a fixed guaranteed rate for a set period of time. These annuities are more risky for the insurance company in that they have to stand behind this guarantee regardless of interest rates and other market factors.

While rare, one risk to keep in mind is the financial strength of the insurance company.