Annuity Insights

9 Questions Every Annuity Investor Should Ask

Investing can be a risky business. Oftentimes, if you want to see your money grow over time, you have to invest in products that may drop in value along the way. Those drops can be scary.

In a seeming effort to address this risk, some investors choose annuities. They may be attracted to “guaranteed withdrawals” or “minimum returns” that seem to take the risk out of investing. In reality, annuities are complex investment vehicles that don’t always provide the simple “safety” they often promise. They typically have high costs, complex restrictions and other risks that could offset the potential benefits. While annuities may not seem risky at first glance, they may not be the best way to limit the risk of losing money.

We created this guide to help annuity owners and those considering annuities better understand this complex investment. We do not sell annuities—our aim is to provide you an insightful view of these products. In this guide, we’ll cover nine questions you should ask to help determine if annuities should be a part of your investment strategy.

1. What type of annuity do I own or am I considering?

Why this is important: Each of the three primary types of annuities has differing risks and benefits. Being aware of these factors can help you decide which annuity type, if any, is right for you.

Fixed annuities typically guarantee a fixed or minimum rate of return over a set time period, similar to a bank Certificate of Deposit. Though fixed annuities generally don’t suffer losses due to their guarantees, other, less restrictive investments may provide similar returns.

Indexed annuities offer a rate of return based on that of a specific market benchmark, like the S&P 500, but typically with a cap on the portion of the market’s return the owner will receive. Additionally, some indexed annuities are based on benchmarks that don’t include dividends, which can limit your total return.

Variable annuities allow owners to invest the premium in sub-accounts, similar to a mutual fund, and they may offer a guaranteed minimum rate of return even if the underlying assets underperform, but fees and other costs can detract from total return. Depending on whether you need your account to grow or provide income, an indexed, variable or fixed annuity may seem like a good choice. Yet there may be more efficient, less restrictive ways to reach your goals.

2. Have I read and understood the contract?

Why this is important: The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) issued a report in 2004 indicating they had received a large number of complaints from individual investors about variable insurance products. Many of these complaints indicated that the customer was sold a variable product without fully understanding the product and expressed concerns that the product may not have been appropriate for them, given their investment objectives.¹

The SEC indicates that before purchasing a variable annuity, you should be prepared to ask your insurance agent, broker or financial professional questions about whether a variable annuity is right for you.²

Don’t rely only on the sales guide, which may not provide the most objective representation of an annuity’s costs and restrictions. The devil is in the details, and the details are in the contract, prospectus and prospectuses for any subaccount funds, which can amount to many hundreds of pages of information and disclosures. 

In contrast, indexed annuities have a much shorter contract also referred to as a “Statement of Understanding.” While these can be much shorter than variable annuity prospectuses, the SEC warns investors that indexed annuity contracts or Statements of Understanding can still be difficult to understand due to confusing features such as participation rates, performance caps, floors and a variety of different crediting methods.³

¹ Source: Securities and Exchange Commission and National Association of Securities Dealers, Joint SEC/NASD Report on Examination Findings Regarding Broker-Dealer Sales of Variable Insurance Products (SEC and NASD, 6/2004).

²Source: Securities and Exchange Commission, Variable Annuities: What You Should Know, SEC Pub. 011 (https://www.sec.gov/investor/pubs/varannty.htm).

³ Source: Securities and Exchange Commission, Updated Investor Bulletin: Indexed Annuities (https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexedannuities).

Annuity providers also often reserve the right to change terms, which can have a significant impact on your investing goals. For example, suppose you plan on contributing regularly to the annuity in order to receive higher income benefits. Some annuity providers reserve the right to limit future contributions in order to avoid paying more in benefits. If this happens to you, you may not be able to receive the income stream you’re counting on today. Fees, participation rates and performance floors and caps may also be subject to change on an annual basis in most cases.

The bottom line is never sign what you haven’t read. Only by reading all of these documents, will you know all of the annuity’s conditions, restrictions and costs. Otherwise, you may not really know whether an annuity is the right choice for your goals.

3. What types of expenses does the annuity have and what is the overall cost?

Why this is important: Many annuities don’t have a single flat fee rate. Many have several layers or fees that, together, can add up to several percent and thousands of dollars annually.