Annuity Questions: What to Ask Before You Buy

Buying an annuity is a big financial decision, like deciding how you’ll get paid during retirement. Think of an annuity a bit like a reverse loan. Instead of you borrowing money, you give money to an insurance company, and they promise to pay you back later, often for the rest of your life. Because it’s a long-term commitment, it’s crucial to ask the right questions upfront to make sure an annuity is truly the right fit for you.

So, what should you be asking before you sign on the dotted line? Here are some key questions to consider:

1. What type of annuity is it? Annuities aren’t one-size-fits-all. There are different types, and understanding the differences is the first step. The main types are:

• Fixed Annuities: Think of this as a very safe, predictable option. Like a Certificate of Deposit (CD) from a bank, a fixed annuity promises a set interest rate for a specific period. You know exactly how much you’ll earn and how much you’ll receive in payments. It’s low-risk but might offer lower potential returns compared to other investments.
• Variable Annuities: These are linked to the stock market. The money you put in is invested in subaccounts, which are similar to mutual funds. Your returns will vary depending on how these investments perform. This means higher potential for growth, but also the risk of losing money if the market goes down. It’s like investing in the stock market, but wrapped in an annuity.
• Indexed Annuities: These try to offer a middle ground. They are linked to a market index, like the S&P 500, but with some protection against losses. Your return is based on the index’s performance, but there are usually caps or limits on how much you can earn, and floors that limit how much you can lose. Think of it as participating in market gains, but with a safety net.

2. What are the fees and charges? Annuities can come with various fees that can eat into your returns. It’s essential to understand all the costs involved. Ask about:

• Surrender Charges: These are penalties you pay if you take your money out early, within a certain period called the surrender period. These can be quite high, especially in the early years of the annuity. It’s like breaking a lease early on an apartment – you’ll likely pay a fee.
• Mortality and Expense (M&E) Fees: These cover the insurance company’s costs for providing the death benefit and other guarantees. They are usually an annual percentage of your account value.
• Administrative Fees: These cover the costs of managing the annuity account.
• Underlying Fund Expenses (for Variable Annuities): If you’re in a variable annuity, the subaccounts you’re invested in will also have their own fees, just like mutual funds.

3. What are the surrender charges and how long do they last? We touched on this above, but it’s worth emphasizing. Surrender charges can be a major drawback if you might need access to your money before the surrender period ends. Understand the schedule of these charges – how long they last, and how much they are each year. Ask for a clear explanation and examples.

4. What guarantees does the annuity offer? Annuities are often sold on their guarantees, such as guaranteed lifetime income. But it’s important to understand exactly what is guaranteed and what isn’t. For example, a fixed annuity guarantees a specific interest rate. A variable annuity might guarantee a death benefit, but not the performance of its investments. Understand the fine print of these guarantees.

5. What are my financial goals for this annuity? Why are you considering an annuity in the first place? Are you looking for guaranteed income in retirement? Are you trying to protect your principal? Are you seeking potential growth? Your goals should drive your annuity choice. If you’re primarily looking for growth, a variable annuity might be considered (with caution), but if you prioritize safety and guaranteed income, a fixed annuity might be more suitable.

6. Are there other ways to achieve my financial goals? Annuities aren’t the only way to save for retirement or generate income. Consider other options like stocks, bonds, mutual funds, or real estate. For retirement income, you could also consider strategies like systematic withdrawals from a diversified investment portfolio. Compare the pros and cons of annuities versus these other options to see if an annuity is truly the best solution for you.

7. How financially stable is the insurance company? Annuities are backed by the financial strength of the insurance company. If the company runs into trouble, your payments could be at risk. Research the insurance company’s financial ratings from independent rating agencies like A.M. Best, Standard & Poor’s, and Moody’s. Choose a company with strong ratings.

8. Can I understand the annuity contract? Annuity contracts can be complex and lengthy. Don’t be afraid to ask for a plain-English explanation of anything you don’t understand. If you’re not comfortable with the terms, don’t buy it. It’s your money, and you need to understand where it’s going and what you’re getting in return.

Asking these questions before buying an annuity will help you make a much more informed decision and avoid potential surprises down the road. Remember, an annuity is a significant financial commitment, so take your time, do your research, and ask plenty of questions!