Tips on Choosing Annuities

Consider the insurance company's rating, the death benefit, investment options and fees when choosing an annuity.

Consider the insurance company's rating, the death benefit, investment options and fees when choosing an annuity.

The primary purpose of an annuity is to ensure you or your partner has an income that you can't outlive. A life annuity frequently involves payments of a specified sum being made by an individual to an insurance company in exchange for the company's promise to make periodic payments to the individual. The payout of an annuity is one factor a couple should consider when evaluating whether or not an annuity will help them meet their investment goals. Other considerations include the quality of the company that issues the annuity, the cost of the investment and the annuity's death benefit.

Company Rating

You can use A. M. Best, Standard and Poor's and Moody's Investor Services to research an insurance company's rating prior to purchasing an annuity. Each of these services rank insurance companies in terms of the financial strength and credit worthiness of the company and the investment vehicles sold by the company. Because you're purchasing future benefits that are guaranteed by the underlying insurance company, the ability of that company to meet its policy, contract, and financial obligations is important. For this reason, limit your list of companies to those with an A. M. Best rating of "A +" or "A++", a Standard and Poor's rating of "AA" or "AAA" or a Moody's rating of A1 or better.

Death Benefit

When you purchase an annuity, you have numerous death benefit options, each of which is priced differently. The value of a death benefit is the greater of your initial investment in the annuity contract or the annuity's account value. In all instances, the death benefit should be at least the amount you invest less the amount of any withdrawals. Similar to insurance, an annuity holder's beneficiary should receive the amount of the original investment if the investor dies after the original investment but prior his receipt of any payments from the annuity. Gordon Williamson writes in "Getting Started in Annuities" that the standard death benefit or an enhanced death benefit should be paid for no additional cost above the standard mortality and expense charges. This M&E fee will be quoted in the contract as "basis points" and calculated as a percentage of the average value of the investment. For example, the National Association of Variable Annuities states that the industry average M&E in 2008 was 1.35 percent.

Surrender Charge

A company may impose a surrender charge if the annuity is cashed in by the purchaser before a specific point in time. The fee, which is calculated as a percentage of the investment, declines over the period during which the annuity is held. The time period in which this fee is charged might be as few as one or as many as 12 years. For example, a surrender charge might be 7 percent of the initial investment if the annuity is cashed in during the first year of the contract. However, if this investment is surrendered five years later, the surrender charge might be 4 percent of the investment. Before investing in an annuity, ask if the contract charges a surrender charge, the amount of the charge and the time period during which the surrender charge is imposed.

Investment Options

Consider the fund options that are made available inside the annuity. Look for an annuity that offers a number of different funds to choose from, such as income portfolios, international portfolios, specialty portfolios and sector portfolios. Also confirm that the available funds represent the major asset classes as indicated by a company's capitalization, which is a measure of a company's size. For example, a company classified as a "mega cap" has a market cap — equity value — of over $200 billion. Major asset classes you might look for when evaluating an annuity include U. S. mega, large or small cap and International large or small cap.

Fees

Mortality and expense and administration charges are fees that can vary greatly from one annuity and another. Fees for annuities that are commission products might vary significantly from the fees of no-load products. You might assume that the M&E fees should be relatively low for a no-load product because no commissions are paid to an agent. However, this expense can vary based on other contract elections such as enhanced death benefit options. As a result, carefully review how the mortality and expense and administration charges are calculated for each annuity you're considering. Also consider the fees in light of the performance of the annuity. The best choice might be a higher-cost annuity that has more product features and consistently performs better than a lower-cost product.

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