How do I Choose the Best Annuity Options?

Annuities are excellent savings vehicles for many people; however, there are many different types of annuities available, designed for different personal and financial situations. Choosing among annuity options to select those most suitable, then, is an important first step in the annuity purchasing process. Prudent consumers will do their research and may even interview two or three sales agents, keeping in mind that interviewing an agent doesn't impose an obligation to buy. Factors to consider when choosing an annuity include your risk tolerance, how the annuity earns interest, whether it can earn bonuses, and what the penalties are for early withdrawal, as well as any other fees associated with the annuity.

In choosing among annuity options, a consumer must first determine risk tolerance. While most annuities guarantee against the loss of the principal invested and some guarantee a minimum annual return, one class of annuities — called variable annuities — carry no such guarantees. The premiums paid for variable annuities is directly invested in securities and can be lost in the market, although some insurance companies limit their clients' exposure in such cases. Fixed annuities guarantee the principal amount against market loss, and are preferable for people who have a low tolerance for risk, such as those age 50 and older.

How an annuity earns interest is one of the most important of the annuity options from which a consumer must select. A fixed annuity guarantees the principal amount. The insurance company issuing the annuity declares a new annuity interest rate every year, based on a number of variables, and such annuities usually incorporate a minimum interest rate per year. A fixed index annuity, also called an equity index annuity, pays an interest rate based on the change in one of the many market indexes, such as the Standard & Poor's 500 (S&P500), with the provision that if the index declines in value, the annuity pays no interest but doesn't lose any principal. Fixed index annuities have generally outperformed other investment options when the market fluctuates because of the power of loss; that is, when the underlying index declines, the fixed index annuity doesn't have to recover the loss before recording an actual gain in value; in a bull market, fixed index annuities performance is merely adequate.

Withdrawing funds from an annuity before it has matured can be costly. Although most insurance companies provide for some level of penalty-free withdrawal, usually 10%, amounts above that level may incur surrender charges based on the age of the annuity. Most annuities mature in 10 to 25 years; penalties on withdrawals in the early years of an annuity can be 10% of the amount withdrawn, although this percentage declines over time. Consumers anticipating that they will need large amounts of the principal at certain points in the future should segregate such amounts into shorter-term annuities of five to nine years; annuities with a maturity of less than five years are rare. The length of the annuity and the associated surrender charges, then, are two related annuity options of critical importance when purchasing an annuity.

Many consumers intend to convert, or annuitize, the annuity into a guaranteed lifetime monthly income stream at some point in the future. Some insurance companies include bonuses on these annuity payments, making them an attractive choice when future income is a prime consideration. However, the bonuses are only meaningful when the annuity is actually annuitized, which happens with less than 10% of all annuities.

Consumers should be aware of any other charges, fees, and sales costs, if any, imposed on the annuity, because these fees can have a serious impact on the annuity's future earnings. For example, some insurance companies deduct the salesperson's commission from the account value, while other companies pay their sales staff from their own funds, leaving clients' funds intact. Since sales commissions on annuities can exceed 5%, deducting them from an an annuity's opening balance can have a tremendous impact on the growth potential of the annuity over its lifespan. With respect to other fees, most insurance companies charge only a single annual maintenance fee on annuities, but some companies impose many more fees. Charges of $50 US Dollars (USD) or more for processing withdrawals, above and beyond any surrender charge, are not uncommon.

Selecting among the many annuity options may seem like an onerous task, but for many, the money involved is a significant portion of their life savings. Eliminating risk and maximizing earning potential justifies the time spent on research and interviewing agents.