- An annuity is an investment product sold by insurance companies. It is a contract between you, the annuity owner (also called an annuitant), and the insurance company. You are able to name a beneficiary on the contract that will receive the remaining value of the annuity upon your death. Deferred annuities have a surrender charge that is assessed if you pull funds out prior to the term, often 3 to 7 years.
There are several types of annuities you can choose from: fixed or variable, immediate or deferred. Fixed annuities are considered conservative investments with little risk. Variable annuities are linked to stock market mutual funds and will fluctuate in value according to the fluctuations of the underlying investments. An immediate annuity means you are taking an income stream from the onset of the contract, and the deferred annuity allows money to grow tax-deferred until you take it out, where it is then treated as income. - An annuity is guaranteed by the insurance company that you are in agreement with, just as your car insurance and home insurance are guaranteed by the insurance company that you hold you policy with. Fixed annuities are often given a principal guarantee, which means that you can pull your money out at any time and you will not be penalized any further than the interest amount. The longer you hold the annuity, the less your surrender charge may be. Variable annuities fluctuate and therefore have no guarantee of principal. Investors like these for the tax benefits and the ability to create a future income stream for life, if needed, through annuitization.
- Since the insurance company is insuring your contract, you want to be sure you are purchasing an annuity contract from a reputable insurance company. All insurance companies are given a rating by companies that specialize in determining liquidity risk with insurance companies and debt securities such as bonds. These companies are AM Best, Fitch Ratings, Standard & Poors and Moody's. Each of these has a slightly different criteria it uses to grade insurance companies. You can feel more secure with a company that has been around for more than 50 years and has a rating of BB or higher with any of the rating companies. The highest ratings are AAA, AA and A; anything below a BB should give you concern over liquidity issues.
- The FDIC insures bank deposits but not insurance companies. The insurance industry is highly regulated, primarily by state insurance agencies and the insurance commissioner in each state. Following regulations means that the insurance company maintains enough liquidity to deal with a catastrophic event requiring immediate payouts of a high percentage of assets. Each state is different in its insurance regulations and requirements.
- Finding an annuity that is suitable for you first requires that you determine what type of annuity you need. If you need an immediate income stream, you will be looking at a fixed immediate annuity to provide a steady stream of income for the rest of your life. If you don't need an immediate income, you should purchase a deferred annuity and talk at a financial adviser about the level of risk you are willing to take. Once you have made the decision of the type of annuity you want, look for a company that has a long history of service and also has achieved high marks with the ratings companies to give you the best peace of mind with your investment.
