I get a lot of questions about annuities – what are they? Do I need one?
So, let’ see if we can unpack this topic a bit and de-mystify the whole topic.
First, an annuity is a fixed sum of money paid to someone each year, typically for the rest of their life. If you want such a fixed sum of income guaranteed for life, you typically have to buy it from a life insurance company. For example, a 65-year old man might pay $200,000 in exchange for $1,000 paid to him each month for the rest of his life.
Second, in order to facilitate this purchase, insurance companies came up with the idea of deferred annuities, which allow someone to put regular deposits into the deferred annuity, in hope of building up a sum large enough to turn into one of these lifetime income streams.
And finally, in hopes of accelerating the growth of deferred annuities, insurance companies came out with “variable annuities.” They are called “variable” because they are allowed to invest your contributions in the stock and bond markets, thereby creating account balances that are no longer stable, but variable (aka, going up and down with the markets).
A variable annuity is very, very complex. And it also tends to be very expensive. The investment vehicles inside the product are like mutual funds but are known as separate accounts. Each of these has their own internal set of expenses. On top of that, the insurance company usually charges a “mortality and expense charge.” That’s basically covering their cost of doing business. And let’s not forget about the surrender charges, levied in the early years of the contract designed to discourage you from taking back your money.
One topic that arises from time to time is, “Should I own one of these variable annuities inside of my IRA?”
