Annuities, explained plainly

Where should you start?

With facts, not opinions. Annuities attract strong views in both directions, and most of what people hear about them is opinion. Richard’s job is to set the opinions aside and show you how a specific contract actually works: what it pays, what it costs and what it asks of you in return.

Immediate or deferred: what’s the difference?

An immediate annuity starts paying right away. You turn a lump sum into income, and the payments are based mainly on the amount you put in, your age and interest rates when you buy.

A deferred annuity waits before paying. During the deferral years the contract has time to grow, and with many contracts an income value grows too. The longer you wait, the larger the income it can generally provide once you turn it on.

The trade-off is time. If you need income now, immediate fits. If retirement income is a few years away, deferring can mean more income later.

What decides how much lifetime income you get?

Three things matter most:

• Interest rates. Rates when you buy shape what an insurer can offer.
• Your age and life expectancy. Payments are spread over your expected lifetime, so the older you are when income starts, the higher each payment generally is.
• The income base. Many deferred annuities track an income base, the value used to calculate your lifetime withdrawals. A larger income base means more income. It isn’t a cash value you can withdraw as a lump sum.

What’s in it for the insurance company?

People ask this all the time, and it’s a fair question. Insurers invest the premiums they collect, mostly in high-quality bonds, and they’re required by state regulators to hold reserves to back the promises they make.

With a fixed indexed annuity, part of that return is used to buy options on a market index. That’s what lets the contract credit interest linked to the index, within limits: a cap sets the most you can be credited in a period, and a floor, often 0%, means a down year credits nothing rather than a loss. Your money isn’t invested in the market directly.

The deferral years work for both sides: the insurer has time to invest, and you have time for your contract to grow. Insurers are in business to make money, and they do. That isn’t a reason to avoid them; it’s a reason to compare them.

Can you move a CD into an annuity?

Yes. How it works depends on where the CD is held:

• A CD in a regular bank account: when it matures, you can use the money to buy an annuity. This is a new purchase, not a tax-free exchange. The CD’s interest has already been taxed each year, and the annuity can then grow tax-deferred.
• A CD inside an IRA: it can move to an IRA annuity by direct transfer, so it stays tax-deferred.

A 1035 exchange is something different: it moves money from one annuity or life insurance contract to another without current tax. It doesn’t apply to CDs.

Before you move a CD, weigh access against return. A CD is usually easier to get out of. An annuity is a longer commitment, and in return the rates are often more competitive. Breaking a CD before it matures can also cost you an early-withdrawal penalty, so timing matters.

“I can’t get my money out.” Is that true?

Not entirely. Most annuities have a surrender period, often several years, when taking out more than the contract allows carries a charge. Many contracts let you withdraw a portion each year, commonly up to 10%, without that charge. The details vary by contract, which is why they’re worth reading together.

It helps to ask yourself a question Richard asks clients: if your investments dropped 10% tomorrow, would you pull your money out? Most people say no. An annuity is a long-term decision in the same way.

Annuities also aren’t designed to compete with stocks. A fixed or fixed indexed annuity’s job is protection and predictable income. A realistic aim is steady growth that keeps up with inflation, without your principal being exposed to market losses.