Understanding annuity basics


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Understanding annuity basics

  1. 1. Annuity InsightsYour Guide to Better Understanding AnnuitiesFisher Investments13100 Skyline Boulevard | Woodside, CA 94062888-886-8546®
  2. 2. 1Types of Annuities:Though annuities can come in manydifferent shapes and forms, there are somecommon definitions of categories andtypes. In exchange for premiums paid, theinsurance company may promise the investorperiodic payments over time, beginningeither immediately or after someaccumulation period. The first is known asan immediate annuity. The second refersto a deferred annuity.Generally, investors purchase an immediateannuity with a lump sum payment, whilemost deferred annuities allow for eitherlump sum or periodic payments.An annuity generally has two phases:accumulation and annuitization. During theaccumulation period, an investor depositsfunds into the account. At the end of theaccumulation period, the investor canchoose to annuitize the funds, meaningconverting the deposited funds into periodicpayments.The two most common types of annuitiesare fixed and variable.On the surface, an annuity may appeara simple, long-term investment product.In its most basic form, you give aninsurance company a sum of money,called a premium, either in a lump sumor periodic payments. In return, you mayreceive a steady stream of paymentsover time.Below the surface, however, annuitiescan be quite complex and requireinvestor due diligence. Terms andconditions can vary widely amonginsurance companies and betweenannuity products. Ongoing regulatorychanges may also impact annuities.Before committing yourself to anannuity, be sure you completelyunderstand how annuities work ingeneral and the specifics of the annuityyou’re considering.
  3. 3. 2Fixed AnnuitiesFixed annuities generally guarantee a fixed orminimum rate of return over a specified timeperiod. However, most annuities reset the fixedrate of return at the end of each pre-determinedtime frame, known as a term. Terms vary acrosscompanies and policies, but are generally one year.A fixed annuity contract can be compared tobuying bank Certificates of Deposit (CDs).Variable AnnuitiesVariable annuities allow premiums to be invested ina limited number of sub-accounts, similar to mutualfunds. These sub-accounts may be invested instocks, bonds, or even cash. Variable annuities mayalso offer a guaranteed minimum rate of return,even if the underlying investments underperform.As with all annuities, funds grow tax-deferredduring the accumulation period, but the growth istaxed as ordinary income upon withdrawal.Equity-Indexed AnnuitiesEquity-indexed annuities contain features ofboth fixed and variable annuities. Equity-indexedannuities offer investors a return based on changesin a specific market benchmark, such as theS&P 500.What Can Investors ExpectFrom Annuities?Annuities can offer unique features and addedbenefits not found in traditional investmentslike stocks and bonds. In exchange, annuitiesoften require investors to accept more restrictiveelements. Here are some features investors shouldknow about annuities:LiquidityDeferred annuities require a specific investmentperiod (typically seven or more years) beforeinvestors can start receiving income from theaccount. During this accumulation phase, theannuity contract may allow for some withdrawals.However, if the distribution amount is greater thanwhat’s specified in the annuity contract, the investorcould pay steep penalties—even if the withdrawal istaken to satisfy a Required MinimumDistribution (RMD) from IRA assets held inan annuity. Keep in mind that the annuitycontract was not written with your RMD inmind, so the distributions allowed by the annuitycontract may or may not coincide with thevarying amounts you are legally requiredto withdraw each year.Death Benefit & Other Insurance ProductsSome variable annuities offer built-in insuranceproducts, even though they are not insurancepolicies. For example, the annuity contract mayinclude a death benefit guarantee to pass moneyto a beneficiary over a set time period. However,investors must pay for additional benefits,reducing the account value over time. Instead,investors may do well to consider purchasingthese benefits more cheaply through an insurancepolicy. Annuities may also offer other insurance-type benefits, though these benefits also comewith a charge and should be carefully analyzedfor benefit.TaxesOne appealing aspect of annuities is the tax-deferred growth of deposited funds. But if youneed money from the account before you’re 59 ½years old, a 10% IRS penalty may be charged forwithdrawals. Additionally, investment gains in theannuity portfolio are taxed at ordinary income taxrates. Depending on your tax status, this maypresent a disadvantage when compared to the taxtreatment of long-term capital gains. For manyinvestors, the long-term capital gains tax rate islower than current income tax rates. Also worthnoting is that gains on death benefit payouts maybe fully taxable—unlike traditional life insurancepayouts.You should consult your tax advisor beforemaking any long-term decisions that couldinfluence your tax situation. This is particularlytrue with annuities, which typically imposepenalties and conditions for short-term changes.
  4. 4. 3Equity-indexed annuities provide returns basedon a stated stock index (ex. S&P 500, MSCI WorldIndex, etc.). Though equity-indexed annuitiesguarantee a minimum return, maximum returns canbe less than the full performance of the underlyingindex. For example, equity-indexed annuitiestypically subtract a “fee” from the benchmark’sgain to determine your rate of return—known as“margin,” “spread,” or “administrative” fee. So ifthe benchmark rose 10% and the fee was 3%, youwould receive a 7% rate of return.Over time, the differences of a few percentagepoints can lead to a lower account value versusinvesting in stocks. For example, compare $1million invested in the S&P 500 Index versusbuying a hypothetical annuity for the 30 yearsending December 31, 2012. The hypotheticalannuity offers 100% participation to the S&P 500Index with an annual 3% minimum guaranteedrate of return and 10% cap:ReturnsThough guaranteed, an annuity’s return may bemuch less than traditional investments like stocksand bonds over time. Prior to entering a multi-year contract, investors should compare otherinvestment alternatives. For example, fixedannuities provide guaranteed interest, but theinsurance company can reset the interest rateperiodically—perhaps below what investors canget from investing on their own in governmentbonds or other fixed-rate investments.The account values of variable annuities generallyfollow the performance of the sub-accounts’underlying investments—bonds, stocks, or moneymarkets. However, management fees, operatingexpenses, and other charges that are associated withvariable annuities can reduce returns relative todirectly investing in bonds, stocks, or moneymarkets over time. In addition, each sub-accountmanager should be evaluated based on performanceand fees similar to an evaluation of any otherpooled investment or mutual fund.Additionally, some annuities tie their performance to a stock index that does not include dividends.Therefore, the annuity’s returns will be lower than an index with dividends, and this could make a differenceover time. For example, from 1926 to 2012, the S&P 500’s annualized return with dividends reinvested was9.7%—without dividends, the S&P’s return was only 5.6%.***Source: Global Financial Data, Inc., as of 04/02/2013. GFD used data from the Cowles Commission and from S&P itself tocalculate total returns for the S&P Composite using official monthly numbers from 1971 to 1987 and official daily data from 1988on. This example is provided for illustrative purposes only. It is not intended to reflect the returns of an actual annuity, and it isnot intended to predict returns of the S&P 500 Index for any other period. Past performance is never a guarantee of future results.Investing in the stock market involves the risk of loss.**Source: Global Financial Data, Inc.; as of 04/02/2013.Investment of $1 Million: S&P 500 vs. Hypothetical Annuity*Amount Invested12/31/1981Time Horizon Annualized ReturnEnd Amount12/31/2011S&P 500 Index $1,000,000 30 Year 10.8% $21,644,281HypotheticalAnnuity$1,000,000 30 Year 7.4% $8,514,089
  5. 5. 4Fees and ChargesAnnuities often have high, on-going fees comparedto traditional investments, e.g. mutual funds. Hereare a few investors can expect:Mortality and expense fees:Insurance companies assume risk when sellingan annuity contract, so they charge these fees tocompensate. These fees may also be part of a bro-ker’s commission for selling the annuity.Operating and administrative fees:These are account maintenance fees. They typicallycover administrative expenses, bookkeeping, etc.Sub-account expense ratios:These are expenses tied to maintaining yourunderlying investments, such as transactioncosts in your mutual funds, etc.Guaranteed Minimum Death Benefit:An additional fee can be charged for this optionalrider, which provides a sum to beneficiaries if theannuity contract owner passes away before thecontract ends.Guaranteed Lifetime Withdrawal Benefit:This optional rider, also available for an additionalfee, delivers a guaranteed income stream (typicallya percentage of the principal) for the remainder ofthe contract holder’s life.*Securities and Exchange Commission, Variable Annuities: What you should know, (Washington, DC: SEC pub 011, 09/2007), 11.**Insured Retirement Institute, 2011 IRI Fact Book (Washington, DC: IRI, 2011), 36-38, 56.Typical Annual Fees for Variable AnnuitiesVariable Annuity Expense Description Annual ExpenseMortality & Expense Risk 1.25%*Administrative Fees 0.15%*Optional Guaranteed Minimum Death Benefit Rider 0.61%**Optional Guaranteed Lifetime Withdrawal Benefit Rider 1.03%**Fund Expense for Underlying Funds in Variable Annuity 0.94%**Total Cost 3.98%
  6. 6. 5A few percentage points in fees can greatly impact returns over time, even if the annuity has the sameperformance as the stock market. Consider the following hypothetical comparison:Surrender fees:Deferred annuities can also carry extra charges, including surrender fees. Surrender fees are penalties forwithdrawing your money before a specific “surrender” period has expired. This period is often around sevenyears, but potentially longer. The surrender fee is generally a percentage of the withdrawal amount and typi-cally declines over the surrender period. For example, the fee may be 7% to withdraw in the first year, 6% inthe second year, 5% in the third year, and so on until the period is over.*This example is provided for illustrative purposes only. It is not intended to predict actual expenses or returns of any investment,which will vary. Past performance is never a guarantee of future results. Investing in the stock market involves the risk of loss.Hypothetical Impact of Fees on Returns*Amount Invested Time HorizonAverage AnnualReturnAnnual Expenses End Amount$1,000,000 20 Year 10% 2.4% $4,927,064$1,000,000 20 Year 10% 1.5% $5,919,929
  7. 7. 6InflationFixed annuities may not protect an investor frominflation. Inflation can be problematic because iterodes purchasing power over time. For instance, ifinflation averages about 3.0% per year,* a $60,000annual payment in 2012 and a $60,000 annualpayment in 2032 are not the same. The purchasingpower is vastly different—$60,000 in 2032 can onlybuy $33,281 worth of goods and services in today’sdollars. Though investors can purchase features toprovide for protection from inflation, there is a fee.Similarly, adjusting your monthly payment later toaccount for inflation may result in penalties.Insurer’s Financial StrengthThe insurance company’s financial strength willaffect its ability to pay added-on benefits—deathbenefit, guaranteed minimum income benefit, long-term care benefit, etc. If the insurance companyfails, annuity owners may not receive all the benefitsthey were expecting. Although many legislativereforms have been considered to better protectinvestors from the impacts of the collapse of afinancial services company, it’s important that inves-tors remain wary of the possibility and ask the rightquestions of their provider’s financial strength.*Source: Global Financial Data, Inc.; as of 01/25/2012. Annualized rate of 2.99% per year. Based on US BLS Consumer Price Indexfrom 1925-2011. Investing in securities involves the risk of loss. Past performance is no guarantee of future results.
  8. 8. 7The Annuity Conversion Program: For Investors Who Own Annuities ...We hope our guide has helped you evaluate whether your annuity may be the bestinvestment for your financial goals. If you own annuities in your portfolio of $500,000or more and would like more in-depth guidance, we urge you to contact us for a freeconsultation with our team of investment professionals.If you determine your annuity may not be the best option for your financial goals, wecan help plan a more appropriate investing strategy tailored to your needs and withoutthe surrender penalties and high fees often found in annuities. We are dedicated tomaking sure you are on a financial path that’s right for you, which is why we maycompensate you for some or all of the annuity surrender fees incurred when liquidatingyour annuity.* We can even help manage the complex liquidation process through yourinsurance company.Through our Annuity Conversion Program, you can benefit from Fisher Investments’expertise and over 30 years of investment industry experience. We’re a nationallyrecognized money management firm that has helped guide thousands of investorstoward their financial goals without annuities.If you believe your financial future is worth a quick conversation with our investmentprofessionals, call us at 888-886-8546. There’s no obligation.
  9. 9. 8*Annuity Surrender Fee Terms and Conditions1. Limited Time Offer: The offer is available for a limited time only. Fisher Investments reserves the right to cancel, suspendor modify the offer at any time and for any reason without notice.2. Eligibility: The offer is available only to qualified investors who become Private Client Group clients of Fisher Investmentsand who surrender an annuity and transfer the proceeds to be managed by Fisher Investments. Nothing in the offer infers anyright on any person to become a client of Fisher Investments. Fisher Investments reserves the right to refuse or terminate anyperson as a client for any reason. Any request to participate in the offer is subject to acceptance by Fisher Investments.3. Conditions:a. The maximum surrender cost that Fisher Investments may agree to pay will depend on the actual surrender cost of theannuity (excluding capital gains and other taxes) and the value of the total portfolio transferred for management by FisherInvestments. Any portfolio already managed by Fisher Investments will be excluded for the purpose of determining themaximum surrender cost to be paid.b. Any surrender cost that Fisher Investments may agree to pay will be payable in equal quarterly installments over several years.Installments are subject to adjustment based on withdrawals of assets from Fisher Investments’ management. All paymentobligations will immediately cease if the client relationship with Fisher Investments is terminated before the end of the paymentperiod and no further installments will be paid.4. Risks: There is no guarantee that any annuity proceeds managed by Fisher Investments will achieve any specified level ofperformance, or that performance will be any higher than what could be achieved within an annuity. Investing in securitiesinvolves the risk of loss. Past performance is no guarantee of future returns.M.01.282-Q2130403
  10. 10. M.01.282-Q2130403© 2013 Fisher Investments. All rights reserved.®