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Library of Congress Control Number: 2023939003
ISBN 978-1-394-16858-3 (pbk); ISBN 978-1-394-16859-0 (ebk); ISBN 978-1-394-16860-6 (ebk)
Contents at a Glance
Part 1: Making Sense of Annuities
Part 2: Identifying the Major Annuities
6: Earning
7: Creating
CHAPTER 8: Gambling on Fixed Indexed Annuities
CHAPTER 9: Aiming Higher with Registered Index-Linked
Aging
Part 3: Shopping in the Annuity Marketplace
Part 4: Getting the Most out of Your Annuity
Part 5: The Part of Tens
Part 6: Appendixes
PART 5: THE PART OF TENS
The Annuity Stanifesto, by Stan G. Haithcock
Are You a Stock or a Bond?: Identify Your Own Human Capital for a Secure Financial Future, by Moshe Milevsky
Don’t Go Broke in Retirement: A Simple Plan to Build Lifetime Retirement Income, by Steve Vernon
Income Strategies: How to Create a Tax-Efficient Withdrawal Strategy to Generate Retirement Income, by William Reichenstein
Lifetime Income to Retire with Strength, by Bruno Caron
Retirement Income Redesigned: Master Plans for Distribution, by Harold Evensky and Deena B. Katz
Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success, by Wade Pfau
Risk Less and Prosper: Your Guide to Safer Investing, by Zvi Bodie and Rachelle Taqqu
Unveiling the Retirement Myth: Advanced Retirement Planning Based on Market History, by Jim Otar
Another Day in Paradise: The Handbook of Retirement Income, by Jeff Dellinger
Introduction
If you’re trying to figure out how to finance your own retirement and how to make your retirement savings last at least for the rest of your life, you’ve come to the right place. This book is about annuities. And annuities are about retirement income planning.
A lot has changed in the world of money, insurance, and retirement since the first edition of Annuities For Dummies appeared in 2008. But two things have not changed: Most people don’t understand annuities well, and middle-class retirees can’t afford not to understand them.
Annuities are inherently complex, and they’re rarely explained well. Most books on annuities say that annuities are contracts between you and a life insurer, with an accumulation stage where you put money in and let it grow, followed by a payout stage where you receive an income for life.
That definition is a bit misleading. Annuities have evolved into a dozen or so complex, specialized products that, in practice, bear little resemblance to one another. Different annuities are sold for different purposes by different kinds of agents or advisers to investors or retirees with different needs.
In this book, I devote a full chapter to each major type of annuity. You can decide for yourself which of them, if any, can solve the particular financial challenge or risk that you’re facing. Everyone who wants to reduce their financial risk should learn about annuities.
My approach to this topic is as unbiased as it can be, but I do have a point of view. My opinions are based on a quarter-century’s experience in Vanguard’s Retirement Resource Center, at Annuity Market News, and as owner and publisher of Retirement Income Journal. I believe that annuities are best used for safe income, as a supplement to Social Security.
About This Book
If ever a candid, consumer-driven book about annuities has been needed, the time is now.
Millions of Americans are reaching retirement with their 401(k) or 403(b) plan savings, their home equity, and their monthly Social Security benefits as primary sources of income in retirement. Aside from teachers, firefighters, and other public-sector workers, not many are covered by adequate “defined benefit” pensions.
Long shelves of books have been published on saving and investing for retirement. Many have been written about annuities. Fewer have been written about combining investments and annuities in creative and efficient ways to replace the pensions most Americans no longer have.
As I write this book in 2023, the annuity industry has reached a turning point. After the 2008 financial crisis, the Federal Reserve lowered U.S. interest rates to near zero and kept them low until 2022. Low rates favor the stock market and real estate market but can be toxic for the popularity of annuities.
The bumpy ride of the “life and annuity” industry over those 14 years deserves a business book of its own. In this updated edition of Annuities For Dummies, I concentrate on the new annuity products and the new life insurers that emerged during that period.
Annuities For Dummies is written and designed for the intelligent nonexpert. Like all For Dummies books, you can read the contents in any order. Its bold headings and icons direct your attention to the essentials. You shouldn’t have to dig very far to find the specific information you need.
Throughout this book, I emphasize that annuities are more readily understood when you recognize their three distinct benefits:
» Tax deferral: When you want to defer income taxes on more savings than the government lets you contribute to a 401(k) plan or individual retirement account (IRA), you can put those excess savings in almost any annuity.
» Protected growth: When you want to invest for growth while receiving guarantees against losses, you can buy one of several flavors of deferred annuities.
» Income for life: When you want to create income during retirement, either right away or in the future, you can purchase immediate or deferred income annuities or deferred variable or fixed indexed annuities with guaranteed lifetime withdrawal benefit (GLWB) riders.
Note: The tax breaks and insurance guarantees associated with annuities tend to complicate matters because they have all sorts of conditions and restrictions. But in this book, I try to keep the bigger picture firmly in view.
Within this book, you may note that some web addresses break across two lines of text. If you’re reading this book in print and want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e-book, you’ve got it easy — just click the web address to be taken directly to the web page.
Foolish Assumptions
When an author sits down to write a book, they try to envision the people — or sometimes a single person — to whom they’re speaking. In the process, they make certain assumptions about that audience. In writing this book, I’ve made a few assumptions that may apply to you:
» You’re looking ahead toward your retirement years, and you’d like to make them more financially secure.
» You know a fair amount about saving and investing for retirement (perhaps through your employer-sponsored retirement plan), but you know little or nothing about annuities.
» You want to participate in the financial decisions that affect you. Even if you leave the details to a financial adviser, broker, or insurance agent, you still want to understand what’s going on and whether your adviser is taking you in the right direction.
» You’re a bit skeptical. You’ve heard or read some negative media about annuities, including lawsuits against salespeople or companies that allegedly prey on retirees.
» You tend to be a risk-averse investor. You understand that the stock market isn’t just a roller-coaster ride for thrill seekers but also a place where prudent people can take steps to protect themselves against its volatility.
Icons Used in This Book
Throughout this book, you find icons that alert you to especially useful tidbits of information. Here’s a guide to what the icons mean:
When you see this icon, look for useful advice that can probably save you time or money or both!
I try to make each chapter as independent as possible. But occasionally I need to remind you of a fact from another part of the book. You see this icon whenever something bears repeating.
The world of annuities can be like a golf course — full of rough patches, water hazards, and sand traps just waiting to add strokes to your score. This icon points them out.
You can skip this stuff if you want to. I put it here for engineering-minded folks who can’t relax until they can account for every nut and bolt.
Beyond the Book
In addition to what you’re reading right now, this book comes with a free access-anywhere Cheat Sheet that includes tips for deciding on an annuity, being annuities-savvy, and shopping for an annuity. To get this Cheat Sheet, simply go to www.dummies.com and type Annuities For Dummies Cheat Sheet in the Search box.
Where to Go from Here
Feel free to dive into this book wherever the headings catch your interest or wherever the table of contents directs you. If you don’t know anything about annuities yet, definitely read Part 1. If you’re already well versed in annuities, but you want to know more about the people selling them to you, skip to Part 3. Part 4 is the capstone section — it tells you how to combine annuities and investments to maximize a safe retirement income.
1 Making Sense of Annuities
IN THIS PART . . .
Define annuities and find out why older Americans spend hundreds of billions of dollars on them every year.
Identify the financial risks that don’t appear until we retire.
Preview the applications, contracts, and suitability forms you’ll need to fill out.
Weigh the pros and cons of the various types of annuities.
Decide if you’ll be a “green zone,” “yellow zone,” or “red zone” retiree.
IN THIS CHAPTER
» Understanding annuities
» Learning the major types of annuities
» Noting the reasons why people buy annuities
» Recognizing the life cycle of all annuities
Chapter 1
The ABCs of Annuities
Like millions of Americans, you’ve probably purchased stocks, bonds, or mutual funds. All those investments involve risks. You may be less familiar with a type of product that can reduce those financial risks, especially for people in or near retirement.
Those risk-reducing products are called annuities.
Of course, annuities aren’t quite that simple. Most annuity brochures and prospectuses contain enough disclaimers, footnotes, and contingencies to keep a dozen lawyers busy. And the tax features of annuities keep a lot of accountants busy, too.
But it’s useful, at least at first, to set aside the complexities of annuities and take a high-level snapshot of what they are and how they work.
If investing is like walking a tightrope and insurance is like a safety net, annuities are both the tightrope and the safety net. They involve risk and guarantees at the same time. Annuities won’t return as much as pure investments can, all else being equal — but they’re not as risky either. If you’re in or near retirement, you may find such a trade-off appealing.
In this chapter, I provide an overview of what annuities are, what they do, how they work, who should buy them, and so on. In later chapters, I dig down into the details. Throughout the book, I also share my own opinions about annuities, based on my experience in writing about the products and the industry that produces and sells them.
Getting Acquainted with Annuities
To a list of life’s mysteries — the curvature of space-time, for instance — I would add annuities. Hardly anyone understands them. That’s a shame, because annuities can bring stability to our financial lives during retirement, which is arguably when we need it most.
Part investment, part insurance
Annuities differ from other financial tools in several important ways. With investments, you may buy stocks, bonds, or mutual funds through a broker. You hope that in the near or distant future you can sell them for a profit. The risk that you may lose money is on you.
With annuities, you’re buying a type of insurance policy or contract. You transfer money from one of your existing accounts (or from another annuity) to a life/ annuity company. The life insurer invests the money and assumes certain risks on your behalf.
Some contracts offer a guaranteed or minimum gain over a certain number of years. Other contracts help your money grow until you retire, with an option to convert your savings to income at some point. Still others help you turn savings into income right away.
In this book, you see references to life/annuity companies, life insurance companies, and life insurers or carriers. These are all the same kind of entity. This book focuses on the annuity businesses of life insurers.
Deferring taxes
Investments and annuities differ in the way the federal government taxes them. When you buy mutual funds and hold them in a traditional brokerage account, the fund distributes or reinvests capital gains, dividends, or interest on which you owe income tax each year.
When you buy an annuity, you pay no taxes on the annual gains until you take the money out (after age 59½, there’s no 10 percent IRS penalty tax on withdrawals). More money stays in your account, so it can grow faster. In that respect, an annuity is a bit like an individual retirement account (IRA). I delve into the tax benefits of annuities in Chapter 18.
The types of annuities that most people buy today are usually long-term tax-deferred investments with protections against loss. Relatively few people buy annuities solely for monthly income in retirement, and only a minority converts investment-style annuities to retirement income.
The different types of annuities are so different from each other (despite several similarities) that I recommend approaching them as distinct products. Different types of annuities are sold by different kinds of agents or advisers to different kinds of clients for different purposes.
Annuities are often sloppily described in the media. The media typically defines them as ways for people to create guaranteed retirement income that starts right away (immediate annuities) or after an “accumulation period” (in the case of deferred annuities) and in the form of either steady or fluctuating payments.
This definition makes it sound as if every annuity ends up as guaranteed income in retirement. That’s like saying that all eggs grow into chickens, instead of getting fried, hard-boiled, poached, or added to cakes long before then. Most annuity owners use them for the benefit of tax deferral and to protect their savings from loss due to market volatility.
WAIT, DID SOMEONE SAY “CONTRACT”?
Yes, buying an annuity means filling out an application, which, if approved, is followed by the signing of a contract. Like those endless software contracts online, annuity contracts can be long, hard to understand, and printed in a font size that strains the naked eye.
The application will acquaint you with the terms of your annuity. It will also require you to make certain decisions about how you’ll fund the annuity, how you want your money invested, and when you want your money back.
Hundreds of thousands of dollars are typically transferred in annuity transactions. Signing your name to the application and/or contract can be scary. But the thought of losing a chunk of your retirement nest egg in a market crash can be scarier. That, along with the tax deferral, is why people buy annuities.
THREE ANNUITIES IN ACTION
Let’s bring this discussion of annuities down to earth with a few concrete examples. Consider these common financial situations:
Imagine that you’ll need exactly $50,000 in five years, and you can’t afford to lose any of it between now and then. You can take $43,000 or so from savings, buy a five-year contract, and receive a guarantee that it will compound by 3 percent or 4 percent each year for the next five years (depending on current interest rates) with no taxes on the annual gains during that period. After five years, you’d have $50,000. Guaranteed. That’s an investment-oriented, fixed deferred annuity.
Or imagine that you’re 70 years old and you’ve saved enough money to cover your essential expenses for the next 15 years but not for 20 years or longer. You can buy an annuity that pays you an income starting next month and lasting as long as you live. Alternatively, you can, with a much smaller premium, buy an annuity whose payments start only if and when you reach age 85. That’s a single premium immediate annuity (SPIA) and a deferred income annuity (DIA), respectively.
Or imagine that you’ve contributed the maximum amount to your defined contribution plan or IRA, but you’d like to save more every year for retirement in a tax-deferred account whose value may fluctuate (upward, you hope) over time. You can put that money in an annuity and let it compound tax-deferred indefinitely. That’s a deferred variable annuity or a structured variable annuity.
Recognizing the Most Popular Annuities
Many books and articles describe annuities as having two stages. In the first stage — the accumulation stage — you contributed to the contract, as you would to a bank account. In the second stage — the income stage — you converted your contributions to a monthly income in retirement.
Long ago, these two stages became decoupled and evolved into two distinct types of annuities:
» Deferred annuities, which are contracts that stay in the accumulation stage indefinitely, with the assets growing tax-deferred
» Immediate annuities, which are contracts that skip the accumulation stage and start paying out monthly or quarterly income shortly after the owner makes a large, lump-sum investment
Each of these two types evolved further. Depending on the type of deferred annuity you bought, your money can accumulate at
» A fixed rate (if the insurance company invested your money in bonds)
» A variable rate (if it was invested in the insurance versions of mutual funds, often called subaccounts)
» An indexed rate (if returns were linked to a market index)
If you bought an immediate annuity, on the other hand, the level of monthly or quarterly income can be
» Fixed (if the money was invested in the insurance company’s bonds)
» Variable (if the money was invested in subaccounts)
Over the years, certain types of annuities have become more popular than others. Deferred variable annuities were the most widely sold from the 1990s up until about 2010. Since then, sales of index-linked annuities have become more prevalent.
In the following sections, you find thumbnail portraits of the annuities most commonly purchased. In Part 2 of this book, I devote a chapter to each.
“Savings account” annuities
When people simply need a safe place to grow a large sum of money for a few years, or if they’re saving for a specific need — a planned wedding, a down payment on a house or car — they may buy a certificate of deposit (CD) at a bank.
Some annuity contracts outyield CDs because life insurers typically invest in longterm corporate bonds that may offer higher returns. These annuities are called fixed annuities, fixed-rate annuities, multiyear guaranteed annuities (MYGAs), or even “plain vanilla” annuities. Your money can grow for terms of up to ten years. You can find out more about these types of annuities in Chapter 6.
Pension-like annuities
If you don’t have a company-paid annuity (a traditional defined benefit pension) to rest your weary head upon in retirement, you can buy a pension-like stream of income from a life/annuity company. The most common names for this type of annuity are: an income annuity, an immediate annuity, or (if you’re into “the whole brevity thing,” as the Big Lebowski said in the Coen brothers’ film) a SPIA.
Options-based fixed indexed annuities
The first fixed indexed annuities (FIAs) appeared in the mid-1990s. These contracts generate earnings for their owners when an equity stock index such as the S&P 500 Price Index rises in value.
Their original name, equity indexed annuity, was changed to fixed indexed annuity in 2007 to clarify their identity as an insurance product, not a security. As I discuss in Chapter 8, FIAs rely for growth on the purchase of options rather than on bond yields or on increases in the value of equity shares.
In 2021, the first fixed index-linked annuity (FILA) appeared on the market. It offers investors a chance for higher gains than they might receive from an FIA. Investors can lose gains that their accounts have already achieved, but their principal remains protected from loss.
Registered index-linked annuities
In 2011, a new kind of annuity was born. Variously called registered index-linked annuities (RILAs), structured variable annuities, or index-linked variable annuities (ILVAs), these contracts bear a resemblance to FIAs. Both rely on the purchase of options on equity (or blended-asset) indexes. A big difference: You can lose principal when you buy a RILA.
Because of that risk, sales of RILAs are regulated by the U.S. Securities and Exchange Commission rather than by state insurance commissioners. More an investment than an annuity, a RILA typically offers higher potential gains than an FIA while also using “floors” and “buffers” for partial protection from loss. You can find details on RILAs in Chapter 9.
Traditional variable annuities
At the peak of the 2010–2020 bull market, Americans had $2.5 trillion invested in mutual fund–like subaccounts in deferred variable annuities. When you contribute to a variable annuity, your money goes into a separate account with your name on it, rather than into the insurance company’s general fund.
Starting decades ago, wealthy investors bought vast amounts of variable annuities, where their after-tax savings can grow untaxed until withdrawn. Between 2005 and 2015, older investors bought mountains of variable annuities with guaranteed lifetime withdrawal benefit (GLWB) riders. These riders enabled retirees to lock in a minimum level of retirement income without locking themselves out of access to their own money. You can find out more about the benefits of these types of annuities in Chapter 10.
