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Annuity 101

This is YOUR money that you want to protect and preserve and NOT OUTLIVE!

I certainly don’t want to overwhelm you, but if you can consume and digest the following, you’ll be ready for the details of the “income stream that you cannot outlive,” which is what an annuity is designed to produce. In order for you to be comfortable enough to choose an annuity, it is imperative that you understand the “basics.” This is my simple explanation that I call, “Annuities 101.”

If you like what you read, and you understand it, then our next step is to meet with you face-to-face. That way, I can answer any new questions you may have, and you’ll also get to meet the author of this valuable information that will PRESERVE AND PROTECT your savings account(s). If it were me, I’d want to meet the doctor who was going to save my life. In this case, it’s YOUR money we’re going to save! I promise that you won’t regret it!

Please note: There are a plethora of annuity companies in the world and I make my living by researching the ones with the best ratings, the best potential for protection and returns, the best bonus offers and the best lifetime income payouts and strategies. They’re NOT all the same.

I want you to have the best one that suits YOU and not the one that pays me the best commission.

Meeting you face-to-face and sharing personal information is VITAL for me to help you choose the perfect annuity that will serve all your needs and allow me to serve you as you enjoy the benefits.

So here we go . . .Here are the basics of the “annuity.”

“Annuities 101.”

What is an annuity?
A CD is a savings account with a bank, right? Similarly, an annuity is a savings account with an insurance company. Simple as that.
Both of them offer a guaranteed rate of return IF you promise to keep it with them for a period of time.
Both charge you a “surrender charge” if you pull out too early. (They HAVE to do this for very logical reasons, and I’ll explain why when we meet).

The bank has the F.D.I.C., which insures your money up to a limit (currently $250k).

The insurance company is strictly regulated by the Feds and each state and are insured by other insurance companies to avoid any losses to your principle and your growth, with much, much, higher limitations than a bank. Because of this and other factors, they can also offer much higher rates of return than a bank offered CD. They are also REQUIRED to keep in reserves, an amount EQUAL to your original deposit. The FDIC does NOT require banks to do this.

Technically, an annuity is an investment made through an insurance company. It is a contractual relationship between an individual and the company. Although annuities are offered only by the insurance industry, they do not have anything to do with life insurance or any other type of insurance coverage. Annuities are marketed and sold through brokerage firms, insurance agencies, banks, savings and loan institutions, financial planners, insurance agents, and investment advisors. When an individual purchases or invests in an annuity, the insurance company gives him or her certain assurances. The guarantees depend upon the type of annuity. Here are the 4 different types of annuities.

  • Fixed annuities have a predetermined rate of return and may be single premium or flexible (multiple) premiums. Flexible premiums (or deposits) are contributory and NOT obligatory. A very conservative choice of annuities. Safe and simple with a minimum guaranteed rate of return, typically higher than a CD rate.
  • Fixed Indexed Annuities (FIA’S) have a fluctuating rate of return based on the performance of the stock market or some index such as the S&P 500, Dow Jones Industrial Average, Nasdaq 100, etc. Basically, one can only gain and never lose principal and interest due to stock market performance. Essentially, if the market is up in any given time period, then your annuity grows too. If (when!) the market falls, you do NOT fall with it, nor do you lose ANY of your earnings.
  • Immediate annuities provide both growth and income, beginning approximately 30 days from the date of the initial deposit. No major growth rate, just income.
  • Variable annuities allow the investor to choose from a series of portfolios that range from conservative to aggressive. These are the most risky of all annuities. And expensive! You are in mutual funds that ride the rollercoaster of the stock market. You can earn and you can lose earnings AND principal.

After 21 years in this business, I have come to realize that an FIA (Fixed Index Annuity) is the “best of both worlds,” in that it offers market-type returns WITHOUT market-type losses. Due to the fact that you can never lose your principal and interest and gains in a Fixed Indexed Annuity, hereafter referred to as FIA’s, they are very popular annuities for people who want to receive better growth than a standard fixed annuity, but don’t want to take on the risk of a variable annuity. Essentially, the “Fixed Index Annuity” (FIA) value can never lose money due to a down market and it guarantees your account values, locking in gains from each year, called an annual reset.
A) During a year of growth, the account value will participate in one or more of the underlying index gains, via linkage to the published returns of the various indices (S&P 500, NASDAQ 100, DJIA, Russell 2000, etc.).

B) During a subsequent down year, the principal and accumulated gains are locked in and carried forward (annual reset) to the next contract anniversary. You don’t gain but you don’t lose ANY of your principal and previous year’s growth!

C) If the markets should recover the following year, the account value again participates in those gains up to a pre-determined cap (typically 12 percent to 15 percent) without having to recover from the previous year’s “correction” (losses).

As with all financial products, there is a “gotcha.” And this one is a choice you have to make. And here it is:

Would you rather have . . .

  • ALL the gains of the market, AND accept ALL the risk and potential LOSSES to your principal and gains?
  • Or
  • A portion of the gains WITHOUT ANY of the risk or losses? That means, NO NEGATIVE EFFECTS from negative market performance!

Because of the absence of a potential drop in account values due to market losses, the FIA qualifies as a fixed product under the licensing regulations with the Department of Insurance Commissioners of all 50 states. 

Your account values grow tax-deferred like a qualified plan (IRA and 401(k)) Simply put, this means that your account value benefits from triple compounding: You earn interest on your principal, you earn interest on your interest and you earn interest on the money you would otherwise have paid in taxes on the interest.

When the markets take an extended downturn after several years of sustained growth (as they did in 2000-2002 and again in 2008), you don’t fall with them. And because they grow tax-deferred, FIA’s are not subject to state and local income taxes during their accumulation phase.

Lifetime income. This is HUGE! An FIA can provide their owners with a stream of income for their entire lifetime, regardless of how long they live. More on this later.
Chronic and terminal illness rider. Some FIA’s will allow an owner to have easy access to cash from their policy, often waiving any surrender penalties when such individuals suffer a serious illness, need at-home care, or become confined to a nursing home.
Penalty-free access, usually up to 10% annually, while the account is growing.
FIA’s also allow the tax-free exchange of one policy for another. An FIA policy owner may exchange their policy for a completely different annuity policy without triggering income taxes.

Cost-free asset rebalancing ~ This option is usually available among the major index choices (the S&P 500, NASDAQ, DJIA, Russell 2000, etc.), as well as a fixed interest option, at policy anniversaries. Basically, you have options every year and I as your advisor will help you make any changes along the way.

The money that you put into an annuity earns interest that accumulates tax-deferred until you begin to make withdrawals or begin to receive regularly scheduled payments. Annuity payments are composed of two parts: interest and return of principal. The return of principal is not taxed since contributions to annuities are made with after tax dollars, unless the contributions were made from a payroll, a.k.a. “pre-taxed” or “qualified” money.

Annuities can be distinguished from life insurance policies by virtue of their different purposes.

  • Life insurance has often been described as protection against dying too soon.
  • An annuity is considered protection against living too long.

Most annuities will waive all surrender charges upon the death of the Owner or Annuitant and will pay out the full Accumulation Value to the Beneficiary.

That’s enough for now. I hope I didn’t overwhelm you. There is certainly more to explain, but I believe you get the main points.

It’s important to know that there are 2 BUCKETS of money inside the annuity.

BUCKET # 1 is the ACCUMULATION VALUE, which consists of your principal, any bonus, and Index interest credited annually. The $ in this bucket is for you to take out up to 10% in annual penalty-free withdrawals, and at the end of the annuity term (typically 10 years), you can walk away with all remaining funds that you didn’t withdraw over the years, including the bonus and the index interest earned.

BUCKET # 2 is the Income Account Value (IAV) which consists of your principal, any bonus, and a guaranteed rate of return, credited annually UNTIL you begin a lifetime payout. This is explained below in more detail.

Many insurance companies have made a number of improvements to the products offered in response to the needs of the aging boomer population as well as stock market volatility. Two of these improvements are “Bonuses” (added to premium dollars) and “Guaranteed Income Account Value Growth”(IAV).

This is another enticing feature of the FIA ~ Insurance companies WANT your business so they are willing to offer you BONUSES on your initial deposits into certain annuities. This can really BOOST your accumulation values and subsequently, your income values.

Bonuses may be added immediately to the initial premium, added over a period of time, or added on the back end of the product. The up front premium bonuses can range from 5% – 30% first year to 45% over many years. Therefore, it is CRUCIAL that together, we examine these offers in full detail so we can chose the absolute best one for you. Just because the bonus may be quite generous, there are “conditions” that must be met to get them. I can explain it in full detail to you, your spouse, and family members, etc., and whomever you choose.

Guaranteed Income Account Value Growth (IAV) can be calculated as simple interest or compounded and can range from 5% up to 8% per year. Length of the income account guarantee varies depending on the client age and their purpose in acquiring the product. The income account value (IAV) will accumulate each year at the contractually guaranteed rate (range 5% to 8%) for a limited period of time (usually 10 to 20 years). The IAV can be realized by the owner when the owner elects to receive income from the account guaranteed for the rest of their life. This is NOT an “annuitization” and the income can be started and stopped whenever the owner wishes. The owner also has access to the actual accumulation balance of the product even though they are receiving income guaranteed for life. There is no obligation to take the income stream as the owner may choose to take withdrawals at will.

Remember that I shared with you (above) the three most common types of annuities are FIXED, INDEX, and VARIABLE. I can’t stress these enough and it’s important that you understand the three so you can choose the right one for you.

1) FIXED is as close as you can get to a CD, but with a little higher interest rate and a stronger protection on your money, due to the reserves that the insurance company is required to have to back up your money. (Banks do not have that same requirement).

2) VARIABLE are just that. They are variable because your money is fully at risk IN the stock market. You could gain as much as you can lose, as well as your principal.

3) FIXED INDEX are the ones I like the most and I’m recommending to you because they give you a higher rate than the fixed account and yet, also enable you to participate in stock market-type returns, but without the risk of losing ANY of your principal and your gains. My parents and most of my clients own these and they’ve NEVER lost money with them since I began providing them in 1996.

Because the Fixed Index Annuity (a.k.a. the “FIA”) is not considered an investment, there is no prospectus involved. There are consumer brochures available for these products and also disclosure and suitability requirements that must be met at time of purchase of the product. Also, there are generally no fees associated with the fixed annuity for mortality and expense, distribution and management fees that you find with “Variable Annuities”.

The “FIA” is ideally suited for both “qualified” assets such as 401(k), 403(b), Roth IRA and Traditional IRA’s, and “non-qualified” money too. Also, two wonderful possibilities can occur in the “FIA”.

1. You will participate in market gains and never any market losses.
2. You can compound your earnings and have a guaranteed income for life.

There is a commission paid on the product which does not reduce the amount of your premium deposit. In direct contrast, “Variable Annuities” have a daily charge deducted from your accumulation value for expenses and fees.

I KNOW you’ll have some questions after reading this and when you’re good and ready, let’s meet and talk specifics. And I’ll bring you any other information you request or I feel would help.

Here’s a quick video that may clarify things:


Your “Retirement Lifeguards” offer you SAFETY and freedom from risk (but still provide substantial growth!)