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Things to consider before purchasing an indexed annuity

by 04/11/2012

There are many things an individual should consider prior to purchasing an Indexed Annuity. The following topics/questions are designed to help you, the purchaser, better understand what it means when you enter into a contract with a life insurance company.

When purchasing an indexed annuity you are entering into a long-term contract with a life insurance company. The use of an annuity allows the insurance company to provide a safe environment for you to invest your money while, at the same time, giving you the ability to participate in market growth without market risk. In order for insurance companies to provide these guarantees, they need time, time to make you money and time to make them money; why else would they do it if not to make money? We often tell our clients that the only way to lose money in an indexed annuity is to spend it. It is very important to consider your current financial situation, financial goals (before and after retirement), and any anticipated and unforeseen needs that may arise in the future. To help with your decision making, it is always a good idea to speak with an experienced financial planner, insurance agent or insurance broker.

What is your risk tolerance? This is very important. As you know when you are in the financial market place (variable annuities, mutual funds, stocks, bonds…) you ride the current wave. Sometimes you are up and life is great, but sometimes you are down and you may begin to question both yourself and your broker. If you like to ride the financial wave, with its attendant peaks and valleys, an indexed annuity may not be for you. However, if you are ready to take advantage of a portion of the ups without the risk of the downside, you should seriously consider the indexed annuity.

Do you need to supplement your income immediately? If immediate income is what you are looking for, it is likely that an immediate annuity, rather than an indexed annuity, is what you need. With correct financial planning it is possible to create supplemental income immediately (short-term 1-5 years) and in the long-term (5 years and beyond). Speaking with your planner/agent about these concerns is imperative.

What if you’re not planning on needing the money? Many of our clients have expressed to us the desire to pass their assets onto their children or other beneficiaries and have no plans to use the money themselves. Indexed annuities are a great tool to do just that. Not only have you invested in a safe, risk-free annuity, you have the ability to participate in market growth and can name one or several beneficiaries. Your planner should be able to advise you whether or not setting up a trust would be beneficial to your particular situation. By keeping the assets in your name, you retain control if your situation changes or if a need arises that requires you to access those funds.

How long do surrender charges apply? Every annuity will have surrender charges. The amount and duration of these charges vary widely with each annuity. Typically, surrender charges apply from 5-16 years. If a bonus is included with your annuity, you will see a longer surrender charge period. You will see a shorter surrender charge period for annuities without a bonus. Generally, the higher the bonus, the longer the surrender charge period. Speak with your planner/agent to ensure that you fully understand the surrender charge period, ensuring that it fits what you are looking for.

What is a cap? Each year the insurance company declares the cap for each index. The cap represents the maximum amount of interest you can earn for that year. For example, if you have a 5% cap, a maximum interest rate of 5% is the most you can earn that year in your annuity. So what does that mean? Let’s look at the S&P 500 as an example. If the S&P had an increase of 10% last year, your increase would only be 5%. If the S&P only had an increase of 4% your increase would be 4%. You can only earn up to the cap in any given year. You also want to be aware of the companies’ guaranteed minimum cap. This is the lowest the cap can go contractually on any given year. Once the cap has been stated, the insurance company cannot change it until the next anniversary date of your annuity contract.

How does the death benefit work? Each company will likely have different methods of paying out its death benefit. It is very important for you to understand the death benefit options, thus ensuring that your beneficiaries receive their benefits, as you intend. Personally, I prefer that death benefits be paid to beneficiaries in one lump sum; however, there are other options that must be considered. For instance, if you are receiving lifetime income from your annuity and your spouse would like to continue with those payments (after your death), a spousal continuation rider is usually available. When the continuation rider is elected, the payment may be reduced. There are simply too many options to discuss in this forum, so please seriously consider how your annuity will payout to your beneficiaries.

To be continued…

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