The 4 Steps to Comparing Annuities
Step 1: Identify The Characteristics of The Annuity
Characteristic #1: Variable vs. Fixed
The first significant distinction between annuities is that of either VARIABLE or FIXED.
A variable annuity is an INVESTMENT product “wrapped” in the guarantees of an insurance policy. Only those persons who are licensed to sell mutual funds AND life insurance can sell them. An important distinction between a variable annuity and a fixed annuity is that in the variable annuity the purchaser carries all the risk for the increase in the cash value of the product. The cash value is invested in mutual funds. The carrier will never guarantee an increase in the cash value of this product, and in fact, the cash value will fluctuate (and may lose value) due to market gyrations.
CASE HISTORY EXAMPLE - MURIEL
Because Alex was a both a licensed securities broker and a licensed life insurance agent he was able to sell Muriel her variable annuity.
A fixed annuity is considered a pure INSURANCE product and can be sold by any adequately licensed life insurance agent. It is viewed as an insurance product because the insurer carries all the risk for the increase in the cash value of the product. In other words, the increase in the cash value will be via periodic interest annuity payments guaranteed by the insurance carrier (even if the guarantee is a range). The cash value will not lose money due to market gyrations just because the cash is never invested in the market. (The cash value may decrease due to fees or withdrawals if the costs and withdrawals exceed the guaranteed growth – but more on that later.)
CASE HISTORY NOTE
Because Josh was a licensed insurance agent, he was able to sell Jim and Jane their fixed annuity. He could not have sold them a variable annuity because he was not licensed to sell mutual funds, nor could he have sold Muriel her variable annuity. Either he or Alex could have sold Bill the immediate annuity he was considering.
Characteristic #2: Immediate vs. Deferred
The second significant distinction between annuities is that of either IMMEDIATE or DEFERRED. These terms refer to when income from the annuity will start.
An immediate annuity must start income payouts after 30 days (if a monthly payout is requested) or after one year (if an annual lump sum is asked for).
A deferred annuity allows payouts only after a specified period of time. After the specified period of time has passed the annuity owner can request income at any time.
Characteristic #3: Single Premium vs. Flexible Premium
The third significant distinction between annuities is that of either SINGLE PREMIUM or FLEXIBLE PREMIUM. These terms refer to how money can be put into the annuity.
The annuity is purchased with one lump sum of money; no other sums of money are accepted.
The annuity is purchased with an initial lump sum of money (usually subject to a minimum); other sums of money (sometimes subject to a minimum) may be added to the annuity on either a regular or irregular schedule.
All annuities are one or the other of these 3 Characteristics.
WHY THIS INFORMATION IS IMPORTANT TO YOU
This information acts as kind of a “road map” for you so you can “locate” exactly what type of annuity you are looking at or for. Do you need all of this info in order to compare annuities? Not really. But you can use this info to rule out annuities that don’t meet your needs. For instance, if you know you will be adding money to the annuity as time goes on you know you will need a flexible premium annuity, and you can simply disregard those that only accept a single premium. Similarly, if you know you do not want to take income right away, you will be disregarding immediate annuities.
CASE HISTORY EXAMPLE – JIM AND JANE
Jim and Jane bought a Fixed Index Annuity. From our three criteria above, we immediately know this is a fixed deferred annuity, which may be either single premium or flexible (this info is not given in the case history). While this gives us a little bit of info about the annuity (the insurance carrier shoulders the risk for the cash-value appreciation, and Jim and Jane have a choice as to when they want to start income), it doesn’t give us enough information to perform any meaningful comparison between it and another annuity.
NOTE: The word Index in the annuity Jim and Jane bought merely refers to the way the interest credited to the cash value of their annuity is going to be calculated. Ignore that word for now; the importance of how the cash value will grow will be discussed in Section C.
CASE HISTORY EXAMPLE - MURIEL
Muriel bought a variable deferred annuity also non-specific for premium. Again, not enough information to perform any meaningful comparison between it and another annuity.
CASE HISTORY EXAMPLE – BILL
Bill was contemplating (but did not purchase) a fixed, immediate, single-premium annuity. In the annuity industry, this is usually called a SPIA (Single-Premium Immediate Annuity – pronounced spee-uh).
6 There are deferred annuities with income riders which can be turned on as early as 30 days after purchase so in that regard they are similar to an immediate annuity. The difference is with an immediate annuity income must start immediately; with a deferred annuity, there is a choice of when to start.