Choosing the right annuity
October 30, 2018 by Sheryl J. Moore
So, if someone has decided that an annuity is indeed right for them, they typically next need assistance identifying which type of annuity they are going to purchase. But which type of annuity is right for this prospect? There are so many choices…
To that end, it is important to consider a fundamental principal of risk:
Risk/Reward Tradeoff: a direct inverse relationship between possible risk and possible reward, which holds for a particular situation. To realize greater reward, one must generally accept a greater risk, and vice versa.
In light of this fabulous tradeoff, there are three questions that must be answered, when researching what type of annuity is most suitable for the purchaser.
1. What level of risk is the purchaser willing to assume with the annuity?
- If most concerned about high minimum guaranteed interest, regardless of the lower level of interest crediting/gains, consider a Fixed Annuity.
- If willing to accept a lower minimum guarantee than a Fixed Annuity, but looking for potentially greater interest crediting/gains, consider an Indexed Annuity.
- If willing to accept no minimum guaranteed interest, and the possibility of unlimited loss in exchange for the possibility of unlimited interest crediting/gains, consider a Variable Annuity
(NEWS FLASH: if a salesperson suggests that Indexed Annuities provide unlimited gain potential – RUN! This individual either misunderstands the products, or is misrepresenting the products.)
Indexed Annuities provide limited gain potential and are not intended to perform comparably to securities products. Indexed Annuities merely credit interest based on the performance of stock market, commodities, or bond index. Don’t be confused; these annuities do not allow you to invest directly in the stock market. They do, however, provide the opportunity to outpace fixed money instruments such as Certificates of Deposit (CDs) or Fixed Annuities.
2. How soon will the purchaser need the regular stream of income payments from the annuity?
- If income will be taken within the first year, consider an immediate annuity (offered in Fixed, Indexed, and Variable types).
- If income will be taken at some time further in the future, consider a deferred annuity (offered in Fixed, Indexed, and Variable types).
3. How many premium payments will the purchaser be making into the annuity?
- If only a single payment will be made into the annuity, consider a single premium immediate annuity or a single premium deferred annuity.
- If making more than one payment into the annuity, consider a flexible premium deferred annuity.
Answering these simple questions makes the annuity purchase process so much easier!
And yet, there is still work to be done… in just the world of deferred annuities, today there are 635 Fixed Annuities, 456 Indexed Annuities, and 404 Variable Annuities. That is nearly 1,500 different annuity choices (and don’t even get me started on the riders)!
While I don’t think we are far from offering annuities direct-to-consumer, today an experienced salesperson with plenty of annuity expertise is invaluable in the annuity purchase process. With or without this person, it is helpful for all parties to the contract to understand the “300-foot view” of the annuity transaction. The sale of an annuity has to benefit the three parties to the annuity transaction:
1. The annuity purchaser – via fair interest rate crediting/gains
2. The annuity salesperson – via fair compensation, and
3. The annuity manufacturer (insurance company) – via a fair profit, i.e. a spread.
Just remember that if any one of the three legs of this “three-legged stool” is off-kilter (i.e. rates that seem too good to be true, or it offers a steep commission for the salesperson), there is another leg on the stool that is correspondingly short. (I assure you that it won’t be the insurance company’s leg of the stool, either.)
Sheryl Moore is President and CEO of Moore Market Intelligence, an indexed product resource in Des Moines, Iowa, as well as the market research firm of Wink, Inc. Her companies provide competitive intelligence, market research, product development, consulting services and insight to select financial services companies. She may be reached at email@example.com.