1. Know your advisor.
The first thing you need to know before making any purchase of an annuity or investment is your advisor. This DOESN’T mean they have to be a friend or a relative. In order to “know your advisor,” two things should take place. First, you’ll have to use your “gut.” What is your “gut feeling” when you meet with the advisor? If your gut doesn’t feel right, then listen to it. The truth is that there are lots of financial professionals that can help you with purchasing an annuity. You won’t have too much trouble finding one. The key is in finding one with whom you feel good working.
The “gut” feel is the first part to knowing your advisor. Part two takes a little homework. First of all, it’s important to understand that the person that will help you with purchasing an 
annuity is a licensed insurance agent. They may or may not be considered an “advisor,” but they must be an insurance agent. If you want to make sure that your agent is properly licensed, we recommend you visit the department of insurance website for your state. You should be able to search for an insurance agent/producer right on that site to confirm their licensure. If you are interested in a variable annuity, you will need to purchase that from a registered representative of a broker/dealer. In addition to having an insurance license, this particular financial professional will also have a securities license. A securities license allows a professional to sell investments, and since a variable annuity is considered an investment, a securities license is required. You can check to make sure an individual is properly securities licensed by visiting www.FINRA.org. Look for a button that says “Broker Check.”
Another very important component to knowing your advisor is to know the companies that he/she represents. Many agents work as “captive” agents. This means they may represent only one insurance company. There is nothing wrong with this type of arrangement; however a captive agent may not be able to offer the exact product that you are seeking. Other agents are “independent.” An independent agent likely has a wider variety of products available to him/her because they likely work with numerous insurance companies. Be sure to quiz your agent on this, and ask him/her whether he/ she is a captive agent or an independent. Ask him/her to provide you with multiple quotes. A good agent should have no trouble accommodating this request.
2. Know your goals.
Knowing your goals is likely the most important item to consider when purchasing an annuity. There are many different types of annuities available for you to consider. Everything from immediate annuities to fixed, indexed, and variable annuities — they all serve different roles in your overall financial plan. An easy way to think about this is to consider this analogy: If you were going to take a road trip from your house down to Miami, Florida, how would you handle it? For a moment, let’s pretend that we didn’t have those wonderful GPS systems that are available now. There was a day not that long ago when people actually bought maps! Can you believe that? If you were taking a road trip to Miami, the first thing you might do is purchase a map. You would then plot out the most efficient course to get to Miami. There might be a number of things you would consider — whether you wanted to take a more scenic route or the most direct route. Some people might want to stop off at a place or two in between for some sightseeing or shopping. The point is that you wouldn’t just hop in your car and go. You would plan it out and think through your trip.
Purchasing an annuity is similar. You have an end goal in mind, but it is imperative to consider some of the other variables. What kind of risk are you willing to assume? What happens if you need access to the money? When will you need access to the money? Why are you considering the annuity? Do you know the pros and the cons?
Each different type of annuity serves a different purpose. An immediate annuity is designed to provide an immediate income stream to the purchaser. But, not all immediate annuities are the same. Do your homework and understand the terms and differences between different types of annuities. For example, there are different kinds of immediate annuities, including lifetime only immediate annuities, period-certain immediate annuities, and combinations of the both. They all serve different purposes depending upon the goals of the client.
Deferred annuities, on the other hand, come in even more different shapes and sizes. A fixed annuity is designed to pay a fixed rate of interest, while variable annuities will fluctuate depending upon the underlying investments of the annuity. An annuity that combines features of both fixed and variable annuities is called an indexed annuity. It has some fixed features, as well as some features that link it to a stock market index. In addition, there are riders available on many annuities today that may provide additional benefits to consumers. With all of the options available on annuities today, it is important to sit down with a financial professional to review which options may be the most appropriate for your unique situation and set of goals.
3. Know the insurance company
There are hundreds of insurance companies in the marketplace today. Annuities are contracts that are issued by insurance companies. The guarantees afforded to the consumer by any annuity are only as strong as the claims paying ability of the issuing insurance company. This is an important thing to consider. When evaluating an annuity, it would be very wise 
for a consumer to consider the overall financial strength of the issuing insurance company.
The most common manner in which to do homework on an insurance company is to consider their financial ratings. There are numerous financial rating agencies in the marketplace. The most common rating agencies are A.M. Best, Standard & Poor’s, Weiss, and Fitch. Another rating system is known as the Comdex score, which utilizes a combination of the rating agencies to rank the various insurance companies. It is important to note that a high rating by a rating company does not insure that a company will remain strong financially, nor does a low rating by an agency mean that the insurance company will fail. However, working with strong insurance companies may be an important consideration that goes into your purchase decision. Do your homework on the insurance company before making a purchase. It may not be necessary that the company you choose to do business with has the absolute highest rating, but you may wish to choose a company that falls in the higher spectrum of the various rating agencies.
4. Know the downsides
Every financial vehicle has tradeoffs. Once you understand this fact, it becomes easier to evaluate your decision. Stocks and bonds have the potential to lose value. CD’s and money markets sacrifice yield, but generally deliver more safety than stocks and bonds. Annuities are no different in that they have downsides as well. If you are considering an immediate annuity, you have to be comfortable with the notion of giving up access to your money because you are exchanging a lump sum of money for an income stream. If you purchase a “life-only” annuity, you have to live with the fact that if you pass away prematurely, you may not reap the most financial gain from your purchase. Conversely, if you live far beyond your life expectancy, you may benefit dramatically from that purchase. If you are considering a deferred annuity, you’ll have to live with giving up some liquidity, since most annuities will charge you a penalty for accessing too much money before the surrender charge period is up.
A financial professional should be able to point out the downsides to each and every financial vehicle they recommend. There is no such thing as the perfect investment or the perfect annuity. No matter the financial vehicle, you will ALWAYS have to be comfortable with giving something up when you make the purchase. The key is in being an educated consumer. Unfortunately, many consumers don’t learn about the downsides to a financial vehicle until AFTER they have made their purchase. If you take the time to learn about the tradeoffs of the annuity you are considering, you’ll be in a much better position to make a smart decision. The following are questions to ask about the annuity you are considering:
- What is the surrender charge period?
- What are the surrender charges? (Also known as early withdrawal charges)
- How much of my annuity will I be able to access in the event of an emergency?
- How long do I have to own this in order to achieve the maximum benefit?
- What are the ratings of the insurer?
- What happens to my annuity if I pass away?
- Will I be able to access these funds if I go into a nursing home or need home health care?
- What will happen to the value of my annuity if the stock market goes down?
- How is interest credited to my annuity? (Translation: How will I make money?)
5. Know the upsides
Just like every financial vehicle has downsides, they usually all have upsides as well (after all, you likely wouldn’t consider a financial product that didn’t benefit you in some way). People who purchase fixed or indexed annuities do so because they provide some principal protection. Conversely, those that purchase variable annuities do so because they have greater growth potential due to the fact that they are invested in stock market subaccounts. Furthermore, those that purchase immediate annuities do so because they can provide guaranteed income streams.
On top of that, many people will factor one other thing into their purchase decision — something called a “rider.” A “rider” is an industry term used to describe an additional feature or benefit that may be available to add-on to the product you are considering. In the annuity world, this usually means some sort of enhanced benefit for income. This could mean they guarantee a certain amount of income percentage withdrawal from your account, or it may mean a guaranteed amount of interest the company will credit to your account in the event you want to withdraw income at a later date. There are also riders available that may provide some sort of death benefit guarantee, in an effort to maximize the amount your beneficiaries will receive from your annuity. It is important to understand that these riders usually have a cost associated with them. It is important to consider these costs before making your purchase because it may not be in your best interest to pay for a rider you never intend to use. Ask your financial professional the following questions to help you gain a better understanding of the upsides in the annuity you are considering:
- Why do you feel this benefits me and my personal situation?
- What are the three main reasons why you are recommending this product to me?
- How will I use the various features in this product to gain the most financial advantage for my situation?
- How long do I have to own this product to get the most out of it?
- How will I earn interest in this product?
- How does the product compare with others like it?
- How does the product compare with the products of other companies?
6. Know your tax situation
Your tax situation will likely play a role in helping you evaluate your decisions regarding an annuity. As you likely know, deferred annuities have the advantage of deferring taxes on gains until you begin to take withdrawals from them. However, annuities also have some additional items of consideration tax-wise that you’ll need to consider. The most glaring one
is the age 59 1/2 rule. An annuity is considered a retirement savings vehicle. Withdrawals from a deferred annuity prior to age 59 1/2 will result in a 10% penalty imposed on the withdrawal amount. This penalty is above and beyond any applicable surrender charges and/or income taxes that would be associated with the withdrawal. This is VERY important for you to consider when evaluating an annuity purchase.
If you are over the age of 59 1/2, this particular early withdrawal penalty is a moot point. But, if you are under the age of 59 1/2, you’ll want to carefully factor this into your decision. Will you be able to refrain from taking withdrawals from this asset until you reach the age of 59 1/2? If not, a deferred annuity may not be the right choice for your investment dollars. There are ways to avoid this pre 59 1/2 penalty — the most commonly used way to avoid this penalty is to take substantially equal payments from the annuity. This is a very specific section of the IRS tax code. In order to do this without penalty, it is extremely important that you follow the guidelines laid out by the IRS. Before considering this, you’ll want to meet with a qualified tax professional to get some guidance.
What other tax items do you need to consider? It is important to understand exactly how annuities are taxed. If your annuity is purchased with qualified retirement dollars (IRA’s, 401(k)’s, 403(b’s), etc.), any withdrawals will be taxed at your ordinary income tax rates. This is true no matter how you take money out, whether through free withdrawals or annuitization. If you purchase your annuity with non-qualified money (money that has already been taxed), you will be taxed in a different manner depending upon how you take money from your annuity. If you annuitize a non-qualified annuity, some of that income will be taxed at ordinary income tax rates, and some of that money will not be taxed, as it is considered a return of your premium. This is known as an exclusion ratio. The exclusion ratio is calculated by the insurance company at the time you annuitize the contract. The ratio will be expressed as a percentage. Whatever percentage is stated is the amount of the income that will be income-tax free. The remaining amount will be taxed at ordinary income tax rates.
If you take income out of the annuity through the use of normal withdrawals, that income will be taxed on a LIFO basis. LIFO stands for “Last In, First Out.” This means that gains in the contract will be taxed first. Let’s suppose that you put $100,000 into an annuity, and after the first year, it grows to $105,000. There is $5,000 worth of gain in the contract. Let’s then suppose that you wish to withdraw $7,000 from the annuity through the use of a free withdrawal provision. You will be taxed on $5,000 at ordinary income tax rates because gains are taxed first. The additional $2,000 of income you received would be considered a return of your basis, and would not be taxed. Your new cost basis in the contract would be $98,000 (which will also be your balance after the withdrawal).
Understanding how taxes may be imposed on income from your annuity is an important consideration. Keep in mind, however, that you would not be taxed if you didn’t take income from the annuity, and allowed it to remain in a “deferred” status. For many individuals, this tax deferral can be an attractive way to reduce current income taxes and defer them until a later date.
7. Know the product
Understanding the annuity you are considering is essential to help you evaluate your purchase. This bit of advice is very similar to the above referenced items (#4 & #5). Evaluate the product, the company, and understand how the product works and may impact your situation. Think about your annuity purchase like you are buying a house. The first thing you do when considering whether you should purchase a house is to evaluate your length of time you plan to own it. Simply put, if you know you are going to move within a couple of years, you might not purchase a home. It probably makes more sense for you to rent in that example. Most people believe that you should plan to live in a house for a certain number of years after you buy it in order for you to benefit financially (this isn’t always the case, but hopefully you get the idea). An annuity is very similar. You don’t buy an annuity without understanding that it is a longer term endeavor. If you are looking for a short term place to park your money, an annuity is likely not your best choice (although there are some shorter term annuities available).
Let’s assume you’ve made the decision that you can commit to something over a period of time. When you buy a home, you will usually walk through it a few times to make sure it has the features you are interested in. Oftentimes, when people buy homes, they have a list of things that they want (location, # of bedrooms, garage, porch, layout, etc.). Quite often, people are not able to get EVERYTHING they had on their list. They evaluate which features are MOST important, and try to find a home that will make them happy. Annuities are very similar. It’s not likely you’ll find an annuity that has all of the features you are looking for… this goes back to the tradeoffs discussion we had earlier in this report. Most people would LOVE to have stock market growth potential coupled with safety and principal protection. Unfortunately, unlimited growth and safety don’t go hand in hand. In order to achieve the growth of the market, you’ll have to assume risk. It’s really that simple. To go back to our home analogy, think of it like this. Let’s suppose you want to purchase a house with lake frontage. But, let’s also suppose that you have a pet and would like a big fenced in backyard. It’s not likely that you’ll be able to find a lakefront home that affords you the ability to have a large fenced in yard. So, you’ll have to give one or the other up. There may be some ways that you could come to a compromise (perhaps a small fenced in area on the side). The same holds true when you buy an annuity, or any investment for that matter. You’ll simply have to accept the fact that you might not be able to get ALL of the features you want. It’s just a matter of identifying the features that are MOST important to you.
8. Know your outs
Life happens. Emergencies arise. Unfortunate occurrences happen at inopportune times. It’s important to know your outs when you make purchases of any sort, whether it’s a house, a car, or an investment. Knowing the rules of the game will make you a better player. Carefully evaluate what will happen if you need access to your money. Does the annuity provide you access to a certain percentage of money should you need it? If you were to ask 100 people what they think of annuities, undoubtedly some will have negative things to say about annuities. The vast majority of the negative comments you’ll hear about annuities have to do with making sure you “know your outs.”
As we discussed earlier, annuities are offered by insurance companies. You likely know that the role of an insurance company is to “pool” risk. The premise behind an insurance 
policy is for the consumer to be able to transfer a certain risk away from them individually. Insuring against the unexpected is a common practice in the United States. When consumers purchase automobile insurance, they are transferring the risk of a costly repair or injury over to an insurance company. This sort of risk transfer is true of every type of insurance. Annuities are a type of insurance product. Different annuities will transfer away certain risks. A lifetime immediate annuity or a lifetime income benefit rider will transfer away a longevity risk (the risk of you outliving your money). Deferred annuities may transfer away other types of risks.
Why is this important to understand, and why is this section of the report titled “Know your outs?” In order for an insurance company to accept this transfer of risk, they need to be assured of certain things. They need to be assured of the fact that you aren’t going to “park” your money with them for a short time, only to take it away from them a short period of time later. An insurance company makes investments with your dollars, and they count on those investments to be there for a certain period of time. If you want access to all of that money sooner than they anticipated, they have to make liquidations. This is the reason why they may charge a surrender fee if you attempt to access all of your money before the contract allows.
Simply put, if you want to get the most out of the benefits and features of a particular contract, you’ll need to play by the rules of that contract. As long as you can live with the rules, and you “Know your outs,” you’ll likely be able to gain the most from your purchase. Don’t be afraid to ask important questions, such as:
- What if I needed to access a certain amount of money due to an emergency?
- What if I die prematurely?
- What if I need this money to help pay for a nursing home or other long term care?
Another important element that you should consider before purchasing an annuity is how it may integrate into your entire financial picture. Do you have other investments? Do you have access to liquid dollars in the event of an emergency? Are you planning a big purchase soon that you may need access to a certain amount of money? How will an annuity play into your retirement income picture? Annuities are simply financial tools. Used for the right purpose, they play an integral role in the lives of many retirees today. Conversely, like any investment tool, if they are used incorrectly, they can have a negative impact on your financial life.
The Next Step….ACTION
Your receipt of this report entitles you to a complimentary no cost or obligation one hour session to explore more about annuities. We encourage you to take the next step and join us for an hour. Any customary hourly planning fees will be waived for this one hour session.
What should you expect at this one hour session? Below are some frequently asked questions about what we call the “59 Minute Financial Wellness Consultation.”
Q: What will this meeting consist of?
A: This meeting is simply an opportunity for you to ask any questions that you may have related to the “what ifs” in life, including how annuities may fit into your specific financial situation, or any other questions you may have regarding your personal finances and retirement. Throughout the course of the meeting, we will ask questions about you and your situation. We’ve found that everyone’s definition of a comfortable retirement is a little different, and that everyone’s situation is unique. Our goal is to learn about your personal goals as we explore how to help you retire the way you want.
Q: Why do you offer this no cost or obligation consultation?
A: Simple. It gives us an opportunity to meet folks from around the area that may have questions about financial matters. It’s no secret that we would love new clients; gaining new clients is the way that our business grows.
However, we want to provide a comfortable environment for exploring a new, potential professional relationship —for you and for us. By offering an hour of our time for no cost or obligation, we provide a non-threatening way for you to spend some time with us to see if it makes sense for us to continue discussions into the future.
Q: Will there be a sales presentation?
A: Not at all. In fact, we are very hesitant to talk about any potential solutions to any questions or concerns you may have. It is important for us to understand your goals and desires about what “retiring” or “investing for your future” means to you. We feel it would be financial malpractice to begin exploring solutions prematurely. We tend to look at the first meeting as an opportunity for you to ask some questions, and for us to get to know each other. Furthermore, we will both be more informed by the end of the meeting, which will help determine whether or not it will be beneficial for us to meet again.
Q: How long will the meeting last?
A: About 59 minutes. Most of our meetings are stacked throughout the day. Future sessions may require more time, but we’ve found that an hour, initially, provides a good basis for getting to know a little more about each other.
Q: What should I bring to the meeting?
A: We are sensitive to the fact that your personal financial information is just that — very personal. However, it is hard for us to help if we don’t, at least, have a fundamental understanding of your financial position. We ask that you bring information regarding your financial accounts, and your previous year’s tax return. However, we follow a pretty strict policy of not looking at any of this until you are comfortable with us doing so.
Q: What will happen after the meeting?
A: If we both decide that it would be beneficial to meet again, we’ll schedule another time to get together. At that meeting we would introduce to you the various areas in which our firm may be able to provide value to your situation. Again, there would be no solutions offered at the second meeting. That would still be a discovery meeting. At that point, you should be in a better position to make an educated decision as to whether you wish to engage the services of our firm.
Q: Who should come with me?
A: We do ask that if you are married, you bring your spouse with you. If you wish to bring any children with you to the meeting, you are welcome to do so. For that matter, anybody that you may utilize in helping you with your retirement and personal finances is welcome to join.
We hope you enjoyed this report!
We look forward to meeting with you!