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July 2009

Annuities: Are They for You?

Readers of “Consumer Checkpoint” often ask meabout annuities: What are they, how are they structured, and what are the potential costs and pitfalls?

An annuity is a written contract between the consumer and a life insurance company where the insurance company commits to paying the consumer a series of regularly spaced payments in return for a premium paid by the consumer. An annuity is not life insurance, a savings account, or saving certificate and should not be purchased for short-term purposes. Rather, it is used for income payments to most often fund a consumer’s retirement.

“Single premium contracts” are annuities where the consumer fully funds the annuity contract in one single premium payment. “Multiple premium contracts” allow the consumer to fund the annuity by premium payments over a period of time. Some contracts allow flexible payments where the consumer may pay how much and when he or she wants, and others schedule payments out over a specific period of time.

A consumer may contract to receive an immediate or deferred annuity payment. Consumers who are still some years from retirement will most likely choose a deferred annuity.

A consumer may also choose a fixed or variable annuity. A fixed annuity generally provides a fixed income payment over the annuity period. The annuity contract will include a current interest rate and a minimum guaranteed interest rate, and the insurance company will normally guarantee that it will pay no less than the minimum rate of interest. If the current rate exceeds the guaranteed rate, the consumer will receive the added benefit. Once payments begin, the amount of each payment will normally be fixed and will not change.

There are also equity-indexed annuities where the insurance company will tie payments to an index such as the Standard & Poor’s 500 Composite Stock Price Index or the Dow Jones Industrial Average.

A variable annuity offers a range of investment or funding options and the consumer is given the opportunity to decide how to invest the premiums. However, here the consumer bears much more of the investment risk.

There are many types and amounts of charges for annuities such as a load fee based on a percentage of premiums paid, a contract fee that is usually a flat dollar charged once or each year, a transaction fee, and a surrender charge if the consumer terminates the contract early.

Consumer advocates are identifying some recent concerns with annuities. For example, the Wall Street Journal in early June published an article, “When an Annuity’s Guarantee Isn’t Always Guaranteed.” Given the recent stock market performance, some retirees are finding they need to rely on their annuity’s guaranteed interest rate to generate a needed amount of funds. The problem occurs when an insurance company contractually cancels the guarantee if the consumer takes an excess withdrawal to make up for a financial shortfall. This can happen if the insurer finds the annuity—due to investment losses—doesn’t contain enough funds to pay yearly fees. If a consumer takes withdrawals before annuity payments begin, it may also create a shortfall of funds needed to make the yearly payments and could result in a guarantee cancellation. If you have an annuity, check with your insurer company to see if this is a risk for you.

I will further explore annuities in future columns. For more information now, see the Wisconsin Insurance Commissioner’s publication, “Understanding Annuities” available at:
http://oci.wi.gov/pub_list/pi-214.htm.


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