What Are Annuities, and What Are the Different Types You Can Buy?
Annuities are insurance contracts that offer regular payments in exchange for purchasing the annuity. Annuities can be fixed, variable, or indexed, and they can be immediate or deferred. Annuities are not always suitable investments for a particular investor, and deferred annuities, in particular, have been the subject of numerous class actions based on claims of high-pressure sales tactics, fraudulent misrepresentations, hidden costs, undisclosed surrender charges, and false promises of bonus premiums. A qualified insurance law attorney can help you determine whether you have been the victim of annuity fraud or were sold an unfair annuity that is unsuitable to you.
Fixed, Variable and Indexed Annuities
The type of annuity you buy determines the level of your payout. In this regard, annuities can be fixed, variable or indexed.
A fixed annuity pays a guaranteed amount according to a fixed interest rate. Since you know your guaranteed rate of return, a fixed annuity is considered a low-risk investment. The rate of return, however, is generally low compared to other types of annuities and is more comparable to the value of a savings account or CD. Fixed annuities offer the lowest return on investment and the least amount of risk.
In a variable annuity, your payout will depend on the performance of the mutual funds in the annuity’s portfolio. Variable annuities typically outperform fixed annuities, but more risk is involved, as the value of the funds can increase or decrease depending on the market. Variable annuities offer the highest return on investment and the greatest amount of risk.
The payout of an indexed annuity is tied to the performance of a stock market index like the S&P 500. Individual stocks have the potential to outperform mutual funds, but they are much more volatile and can lose more value as well. By tying the annuity to an index of blue-chip or high-performing stocks, this risk is somewhat reduced while still generally generating a high rate of return. Fixed-indexed annuities guarantee a minimum amount of income regardless of the performance of the index, but the maximum you can obtain from a rising market is capped as well.
Immediate and Deferred Annuities
They type of annuity you buy also determines when you start receiving payments. With an immediate annuity, you begin to receive payments anywhere from a month to a year after you purchase the annuity. Basically, you buy the annuity in one lump-sum payment, and that money is returned to you, with interest, in monthly payments for the remainder of your life (life annuity) or a set period established in the annuity contract (period certain annuity). An immediate annuity is a way of generating a guaranteed monthly income for your lifetime.
In a deferred annuity, payments won’t start until at least a year after you buy the annuity. Sometimes, payments won’t start for many, many years. Deferring payments far into the future may be part of your investment strategy if you won’t need the money until then, but it can backfire by locking up money you might need for a medical emergency or long-term care. If you access a deferred annuity before its time, you’ll have to pay sizable surrender charges. Also, some deferred annuities put the payments so far in the future they exceed the annuitant’s life expectancy. In this case, the annuity sale was potentially unfair or fraudulent, and you might want to consider talking to an attorney about your rights.
Deferred annuities grow tax-free, but you pay taxes on the payments when you receive them. This is generally a good tax avoidance strategy, as most people are taxed at a lower rate after they retire than at the time when they purchase the annuity. However, you can get hit with a penalty for taking payments before age 59 ½. Also, your disbursements are taxed at your ordinary income rate, whereas returns on other kinds of investments can get taxed at the long-term capital gains rate, which is generally lower. Some retirement contributions, like to a 401(k) or IRA, reduce your taxable income in the year you contribute. One tax strategy might be to max out these kinds of contributions first, and if you still have money to invest for retirement, consider whether an annuity might be appropriate.
Were You Sold the Wrong Annuity that You Didn’t Want or Need? An Insurance Lawyer can Help.
It’s the insurance agent’s job to make sure you fully understand what you are getting into when you buy an annuity, including being fully informed of surrender charges, roll-up rates, period certain annuities, contract fees and contract value, among other terms. If you feel the agent negligently failed to mention important features of the annuity or intentionally misled you or lured you into an unsuitable annuity, talk to an insurance law attorney about whether you have a claim for a fraudulent or unfair annuity. If the insurance company is regularly promoting unfair annuities, a class action lawsuit might even be appropriate.
