In my experience, people have strong feelings about annuities. Here is your guide to understanding the basics of annuities.
They are Insurance
They are offered exclusively by insurance companies. To understand what they are, you must view them through what insurance companies do. As with any insurance policy, they assume the risk for a price. If you have life, car, or home insurance, all you are doing is paying an insurance company a premium for the benefit of them covering an unexpected loss in your life. If you understand that, then you understand annuities. Essentially, annuities seek to transfer some investment risk from an investor to an insurance company – for a price.
Three main types
Insurance companies are creative. They constantly crunch numbers to reposition their offerings and recraft their sales pitches. Because of that, there are many different flavors of annuities, but they fall into three basic types.
The first is called fixed annuities. These are the simplest of the options. In this case, you would give an insurance company a chunk of money, and they would agree to pay you a fixed rate for a certain number of years.
The second is an offshoot of the first, but I like to keep them in the second category. They are indexed annuities. These do not offer a fixed return but rather the opportunity to tie your potential return to a market index. These generally seek to give you exposure to market-like returns while protecting against some of the potential losses and capping some of the potential gains.
The last and most complex are variable annuities. Traditional variable annuities offer investments in stock and bond markets through subaccounts, like mutual funds. Generally, “riders” are added to the policies to provide a death or income benefit. Commonly, income riders are added to guarantee that the insurance company will pay you some percentage of the annuity value for the rest of your life.
As I said, they offer investors the opportunity to transfer investment risk to the insurance company for a premium. Now the first two types I mentioned, their premium is measured in opportunity cost.
Variable annuity premiums are more in the form of higher expenses that you typically see investing directly in the market via mutual funds or exchange-traded funds.
The Rub
Annuities are and can be complicated. Complicated products require a meticulous examination of precisely what is offered. Bad experiences result from unmet expectations and detailed evaluations of investment products from expectations. You must dedicate time to understanding these if you are considering one.
The other thing you should know – certain annuities pay relatively high commissions. This, perhaps, is not as bad as it used to be, but if you do purchase an annuity, make sure you know how much the person selling it to you stands to make.
In all seriousness, this is not a solicitation for annuities. This is solely for you to understand the concept of annuities so you can be a more informed investor. All investments should be carefully considered and thoroughly detailed before investing.
What do I think about annuities? Well, I would love to share my brief thoughts with you… I can reach me at 210-201-0051 or at Austin@greenwingwealth.com.