Annuities 101

Let’s assume that you don’t know what an annuity is, states Chris Sumner, Founder of RS Financial Group. No worries. Most everyone knows what life insurance is, so let’s just start by making a comparison to life insurance.

Life insurance protects against the risk of death, or dying too soon; if the insured person(s) die, the insurance company pays out a sum of money to one or more designated beneficiaries; An annuity is sometimes referred to as “the opposite of life insurance.” Annuities insure against the risk of life, or living too long; the insured person receives a stream of income they cannot outlive from the insurance company.

Hold on- before making this decision, you should also consider a fundamental principal of risk:

Risk/Reward Tradeoff- a direct inverse relationship between possible risk and possible reward, which holds for a particular situation. To realize greater reward, one must generally accept a greater risk, and vice versa.

  1. What level of risk I am willing to assume with the annuity?

  2. • If interested in high minimum guaranteed interest, regardless of the lower level of interest crediting/gains, consider a Fixed Annuity.
    • If willing to accept a lower minimum guarantee than a fixed annuity, but looking for potentially greater interest crediting/gains, consider a Fixed Indexed Annuity.
    • If willing to accept no minimum guaranteed interest, and the possibility of unlimited loss in exchange for the possibility of unlimited interest crediting/gains, consider a Variable Annuity.
  3. How soon will I need the regular stream of income payments from the annuity?

  4. • If income will be taken within the first year, consider an immediate annuity (offered in Fixed, Fixed Indexed, and Variable types).
    • If income will be taken at some time further in the future, consider a deferred annuity (offered in Fixed, Fixed Indexed, and Variable types).
  5. How many premium payments will I be making into the annuity?


  6. • If only a single payment will be made into the annuity, consider a single premium immediate annuity or a single premium deferred annuity.
    • If making more than one payment to the annuity, consider a flexible premium deferred annuity. There are also two different classifications of annuities: deferred and immediate.

  7. What is a deferred annuity?

    An insurance product whereby at least a year will elapse between when the lump sum or series of premium(s) are paid, and the annuity is transitioned into a stream of income through annuitization. Deferred annuities can be Fixed, Fixed Indexed, or Variable in nature.

  8. What is an immediate annuity?

    An insurance product whereby a lump sum premium is paid and the annuity is transitioned into a stream of income through annuitization within one year from the date of purchase. Immediate annuities can be Fixed, In-dexed, or Variable in nature.

    Deferred annuities typically are used as vehicles for accumulation, or building additional interest until the annuitant is ready to transition the annuity to a series of payments through a process called “annuitization.” Alternatively, an immediate annuity is often used as a vehicle for individuals who are ready for their income stream to begin, well, immediately.

Annuities 101

What is a Fixed Annuity (FA)?

A contract issued by an insurance company that guarantees a minimum interest rate with a stated rate of excess interest credited, which is determined by the performance of the insurer’s general account. Multi-Year Guaranteed Annuities (MYGAs), a type of Fixed Annuity, guarantee a minimum interest rate for more than a one-year period; this rate is also determined by the performance of the insurer’s general account. A Fixed Annuity is considered a low risk/low return annuity product.

What is an Fixed Indexed Annuity (FIA)?

A contract issued by an insurance company that guarantees a minimum interest rate of zero, where crediting of any excess interest is determined by the performance of an external index, such as the Standard and Poor’s 500® index. In addition, Indexed Annuities have a secondary guarantee that is payable in the event of death, surrender, or if the external index does not perform. This secondary guarantee is referred to as a Minimum Guaranteed Surrender Value (MGSV); it credits a rate of interest between 1% and 3% on a percentage of the premiums paid in to the annuity.

What is a Variable Annuity (VA)?

A contract issued by an insurance company that has no minimum guaranteed interest rate, where crediting of any excess interest is determined by the performance of underlying investment choices that the annuity purchaser selects. A Variable Annuity is considered a high risk/high return annuity product.

In your evaluation of annuities, it helps to understand the “300 foot view” of the annuity transaction. The sale of an annuity has to benefit the three parties to the annuity transaction:

1. The annuity purchaser- via fair interest rate crediting/gains
2. The annuity salesperson- via fair compensation
3. The annuity issuer (insurance company)- via a fair profit, i.e. a spread

We refer to this as the “three-legged stool” of the annuity transaction. To fully understand, it also helps to consider how the insurance company makes money by selling annuities. Simplistically, the insurance company invests the annuity purchaser’s premium payment(s) in different investment vehicles, in order to make a return that is high enough to pay administrative costs (such as the salesperson’s compensation), credit interest to the annuity purchaser, and still retain a profit. So, let’s consider an example, using Fixed Annuities as a point-of-reference.

• The Fixed Annuity purchaser submits a payment of $100,000 to the insurance company for her 10- year annuity;
• The insurance company invests the annuity purchaser’s premium payment in bonds (This ensures that they will receive a guaranteed return on the monies, and be able to pay the annuity purchaser a guaranteed interest rate);
• Assume that 10-year bonds are paying a rate of 4.00% to the insurance company;
• The insurance company then credits [4.00% - X] to the annuity purchaser’s 10-year fixed annuity contract [the value of X is determined by knowing what amount the insurer needs to cover their expenses (i.e. salesperson’s compensation) and the amount of profit the insurance company intends to keep].
Now, with Fixed Indexed Annuities, the example above is only modified slightly.

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Investment advisory services offered through Virtue Capital Management, LLC (VCM), a registered investment advisor. VCM and RS Financial Group, LLC are independent of each other. Fiduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance product sales, including annuities, life insurance, and long term care insurance or broker dealer services. Advisory clients are charged a monthly fee for assets under management while insurance products pay a commission, which may result in a conflict of interest regarding compensation. IAR is also a licensed insurance agent. In this capacity, IAR may offer fixed life insurance products and receive normal and customary commissions. The client is under no obligation to purchase products through IAR on a commissionable basis. In addition, IAR may receive other compensation such as fixed or variable life trails. The potential for receipt of commissions and other compensation when IAR acts as an insurance agent may give IAR an incentive to recommend insurance products based on the compensation received.Any guarantees mentioned are backed by the financial strength and claims paying ability of the issuing insurance company and may be subject to caps, restrictions, fees and surrender charges as described in the annuity contract. Index or fixed annuities are not designed for short term investments.