Recently, several financial institutions began offering an annuity targeted for retirees which “guarantees” a certain level of income paid periodically to the recipient of the annuity.

Take a look at the factors you should consider before making a decision.

What is a Guaranteed Income Annuity?
A guaranteed income annuity is an insurance contract in which the annuity provider agrees to make minimum regular payments to you in exchange for a lump sum initial payment or a series of payments made by you.  The annuity is considered to be a hybrid product with certain characteristics of a variable annuity (exposure to the market) and also fixed annuity features (guaranteed minimum income levels).

Time Horizon
You can elect to receive payments for life (Lifetime Annuities) or a predefined time period (Term Certainty Annuities; usually 1-25 years).

When You Receive Payments
You can elect to receive payments monthly, quarterly, half-year, or yearly.

Fees
The annuity provider often charges a sales commission % (~5-10%) on the transaction in addition to the annual administrative fee (~1.5%).  For instance, before you invest the $100,000 in an annuity product, you may be charged a sales commission of $10,000 and after the first year an administrative fee of $1,350.  In addition, most annuities have a clause that if you sell or withdraw from an annuity 6 to 8 years after the initially purchase was made, you will be charged a surrender fee (~7%).

Tax Considerations

Investor makes premium payments using AFTER-TAX Dollars

Tax-Free Appreciation on the Principal until you make a withdrawal that is taxed at ordinary income rates (~10-35%, dependent on your tax bracket).

You may transfer your money from one investment option to another without bearing any taxes.

Early Withdrawal Penalty – Usually if the investor withdraws the principal amount prior to the age of 59 1/2, the investor will be burdened with an additional 10% penalty tax in addition to the ordinary tax (~10-35%) you already owe on the amount withdrawn.

Primary Benefit vs. Other Variable/Fixed Income Annuities
These types of annuities have the ability to be invested in the Market while guaranteeing a minimum amount of retirement income (limits downside risk).

Primary Drawback vs. Other Variable/Fixed Income Annuities
These types of annuities are usually more expensive since there is a guaranteed income component.

Some Questions to ask yourself when considering a Guaranteed Income Annuity

Is the annuity provider a financially sound company with stable cash flow?

If not, you probably want to consider using another provider because this will no longer be considered a conservative investment.

Do I understand how the annuity works and all the terms associated with the contract?

Make sure YOU read and understand the contract.  The financial advisor providing the contract may explain the product to you over the phone but it is VERY IMPORTANT THAT YOU READ AND UNDERSTAND ALL THE DETAILS ASSOCIATED WITH THE CONTRACT.

What is the Fee Structure?

Know what the sales commission, admin fee, and any other fees are before you make a decision.  The best way to compare products is NOT by % Charges but by FIXED $ Amount.

How much income is guaranteed?

Worst-case scenario, you want to know how much will be leftover if the market plunges and for how long you are guaranteed that income.

How long the surrender period is and what will I be charged if I withdraw during this period?

As noted previously, you can be penalized for withdrawing during the surrender period (typically 6-8 years).

Does the guaranteed income step-up during a falling market or only during a rising market?

If there is no step-up income provision during a falling market then effectively there is NO GUARANTEED INCOME level.

A Fixed Annuity is Another Option
A fixed annuity pays a set interest rate during the accumulation period and a predetermined amount during the annuitization period.

Key Features
1) Steady stream of cash flow
2) Similar to CDs (Certificate of Deposit) but offer a higher premium
3) Similar to Bonds but principal value doesn’t fluctuate
4) Susceptible to inflation unless a provision is applied to the annuity that protects the investor from the inflation

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