In our recent article “All About Annuities – Part I” we explained to our readers that there
are three basic types of annuities available: the immediate-fixed annuity, the deferred-
fixed annuity and the variable annuity. That article can be viewed in a past issue of this
publication or by viewing it on our website (see link below) in the “In the News” section.
In that article we explained in detail the features of immediate-fixed annuities. In this
article we will briefly explain the features of deferred-fixed annuities and variable
annuities.
Deferred fixed annuities are similar to immediate-fixed annuities, yet different. As you
may recall from our earlier article, when you purchase an immediate-fixed annuity, you
pay a lump sum up front in return for monthly payments for the rest of your life, or for a
guaranteed period of time. With deferred-fixed annuities, a sum is invested for a fixed
period of time with a promise of a typically CD-like return. At the end of the fixed period,
the balance may be withdrawn or annuitized (Annuitizing the balance is basically
equivalent to buying an immediate fixed annuity with the proceeds). Like CD’s, there is
a penalty for exiting early and the surrender period typically lasts for several years.
So when might a deferred-fixed annuity be right for you? It could be right for a retiree
who is still working and doesn’t yet need the annuity income but wants to be assured of
lifetime income. It is not uncommon for these annuities to come with high, teaser rates
that last for only a year or so, followed by much lower returns for the remainder of the
deferral period. Many buyers think they are getting the higher return for the duration of
the deferral period. In many cases you may do better just investing an a CD and later
purchasing an immediate-fixed annuity. Income and annuity payments (if you opt for
annuitization at the end of the deferral period) are both taxed at ordinary income tax
rates, just as CD income would be.
When you buy a variable annuity, instead of receiving a fixed return, a basket of mutual
funds (typically bond and stock funds) are available to invest in. Proceeds grow tax-free
for a number of years, at which time you can annuitize your account and receive
payments for as long as you live. Variable annuities carry surrender fees for five to
seven years typically; although some last even longer.
Variable annuities are products of insurance companies since they provide insurance
for the principle invested in case you should die after a market decline, and provide
benefits during your lifetime (Hence, payouts require actuarial analysis just as do life
insurance policies). All earnings are subject to ordinary income tax.
Sales personnel tout the benefits of insurance on the principle invested and the tax
deferral on the earnings. High sales commissions are typical with these products and
there have been many abuses in recent years. We do not generally recommend these
products (especially for seniors) due to the lack of flexibility from the long surrender
periods and the ordinary-income-tax treatment they receive on income earned.
Variable annuities come with a variety of annuitization options and other bells and
whistles that make them difficult to understand, even for a trained investment advisor.
In the third article of this series, we will discuss some of the pros and cons of these three
types of annuities along with some of the newer, more complex products now being
offered.
David C. Patterson, CFP® and Erin Patterson, CFP® are the owners of Patterson Advisors, LLC, a fee-
for-service-only financial advisory firm. Patterson Advisors, LLC is a Registered Investment Advisor,
registered with the State of Michigan, helping clients in Waterford, Clarkston and Royal Oak, Michigan
as well as other Oakland County, Michigan communities . Visit www.pattersonadvisorsllc.com for more
information or call 248-674-2108.
Published in the Oakland Insider, March, 2008,
All About Annuities - Part II
By David and Erin Patterson