Karl Klinger, CFP®, CLU®

Providing Personal and Small Business Financial Services

Virginia Beach, Virginia

Recent research from the Financial Planning Association ^® (FPA ^®) shows that planners are embracing annuity products to help a more conservative generation of clients protect assets and reach their retirement goals.  Apparently the White House is getting in on the annuity bandwagon as well.

The question is, should you?  First, start with the definition.  An annuity is a financial product that accepts funds from an individual with a plan to grow them, and then at a specific time begins a stream of regular payments to guarantee a steady flow of cash to that individual until they die.  Annuities come with various features, which will be detailed below.

The whole notion of guaranteed payments after an economic crisis seems to be more attractive these days.

A report in the April FPA Journal of Financial Planning stated that 35 percent of advisers surveyed said the recent financial crisis had changed the way they viewed annuities and as a result, they were more likely to use or recommend them than they were before the crisis.  Washington also appears to be getting friendly with annuities as a conservative solution for those in retirement.  In January, the Obama Administration released a report from its Middle Class Task Force favoring annuities as one of a series of tools that might offer guaranteed life income to millions of Americans.

Annuities have plenty of promoters and detractors, and it's best to start by reading as much about them as possible first, and then discussing your retirement savings choices with your tax professional and an Certified Financial Planner^™ professional.  Some basics:

Annuities come in two flavors -- fixed and variable:  Fixed annuities offer a return that is either set immutably in the contract, or tied to market interest rates or a particular index, meaning the future value of the annuity is "fixed" to a specific formula.  Variable annuities are invested in a series of investments -- called separate accounts -- that allow the investor to select and change his investment allocations.  If you are willing to pay additional fees, you may be able to receive additional guarantees from the issuing insurance company that may help offset possible market declines.

Tax-deferred growth, but payments are taxed as ordinary income:  Just like a 401(k) or IRA, the contributions and earnings within an non-tax qualified annuity grow tax-deferred until the funds start coming out.  But also like a 401(k) or IRA, you pay a 10 percent penalty for early withdrawals if you are younger than age 59½.  All withdrawals that aren't a return of your investment dollars are treated as ordinary income and don't qualify for more favorable long-term capital gains treatment.

Money for life, but check the company thoroughly:  The number one selling point of any annuity is that the issuer -- the insurance company that issues an annuity contract -- guarantees that you will receive money for as long as you live.  Of course, you need to make sure the insurance company behind the annuity contract is financially healthy.  Check its Comdex ranking, which is an average percentile ranking of credit ratings provided for life and health insurance companies by firms such as Moody's Investors Service, A.M. Best Company and Standard & Poor's Corporation.

Fees and contingent surrender charges can be steep:  Always ask how much the surrender charges are if you withdraw money from the annuity earlier than planned.  And be sure to compare ongoing fees on any annuity products you consider.  Keep in mind that some annuities may charge a surrender fee if you withdraw your money before age 59 ½ in addition to the 10 percent income tax penalty.

Compare promised returns:  We're still in a low interest-rate environment.  Understand how any annuity you're considering will react in various interest rate scenarios.

Check out consequences of transferring an annuity:  Find out what the tax and economic ramifications might be for transferring an annuity to spouses or other family members when you die.  This effort should be part of an overall review of your personal finances and the creation of an estate plan.

Stay diversified:  Keep in mind that putting everything you have into an annuity is not good financial planning.  Discuss how you should allocate all your assets as you head into your retirement years.