Which Companies Offer the Best Annuities?

The search for the best annuities is complicated by the fact the annuity marketplace is vast, with hundreds of products from which to choose. Narrowing down your choice is no easy task considering there are many different features to understand and compare. It’s no wonder that many people give up trying to find the best annuities or avoid them all together. The task is undeniably daunting, but can be made much easier if you begin, first, by narrowing your search based on the companies that offer them.

The annuity marketplace is always changing as new products are introduced with lower costs, better features and new guarantees. Also, the annuities considered to be the best yesterday, may not be the best today because their past performance is not a good indicator of future performance. But, there is one way to evaluate and compare annuities that will increase your chances of finding the best products, and that is by focusing on the companies that issue them.

Some companies are just better at producing certain products than other companies, and they have developed a track record that is the best indicator of how good their products are compared with others. All life insurance companies have the potential to come out with the new best thing in annuities, but usually it takes time for the market to recognize them. If you need to invest today, you don’t have that kind of time. Instead, focus your efforts on companies that have consistently produced superior annuity products.

Characteristics of Top Annuity Companies

Established annuity provider:

Annuities have been around for a long time. Until the 1980s there were really only a handful of life insurers that issued them. As their popularity exploded in the 1980s and 90s, nearly every life insurer hopped on board the annuity train, some as recently as just the last decade. Companies that have been providing annuities the longest tend to be the best at providing quality products, superior customer services, and more stable returns. What they might lack in innovation (newer annuity providers tend to act more quickly introducing new products and features), they make up for in consistency which most annuity investors want more than anything else.

Solid investment experience:

Annuity investors want competitive returns on their investment. But more than that, they want more stability and predictability for their returns. With fixed annuities, the return is determined by the yield generated by the life insurer on its general account investment portfolio, which is invested in mix of long term, short term, good to superior quality, and government and corporate bonds. Companies with better investment experience are able to manage their portfolio for better and more consistent results, which means that their annuity owners will benefit from higher yields.

With variable annuities, it is important to evaluate the management of the separate investment accounts. While past investment performance should not be an indicator of future performance, you can tell a lot about an investment account by studying the investment managers. How closely has their past performance matched their stated investment objectives and philosophy? How much turnover is there in the management team? Teams that turnover members frequently tend to generate inconsistent returns.

Strong product platform:

While too many choices can create confusion, it is important to have a good selection from which to choose. Annuity products are becoming much more specialized to address the varied needs and objectives of investors. One product might offer a really high rate guarantee with a long surrender period, while another offers a lower rate and less of a guarantee with much more liberal withdrawal provisions. It’s important to know what your priorities, preferences and risk aversions are, and then be able to match them with the most suitable product.

Superior customer service:

The Best of the Best

If there is one place where you should start your evaluation of life insurance companies it is with their financial strength and stability. Annuities are contractual agreements in which the obligations for securing your principal and guaranteeing your returns are only as solid as the ability of the life insurer to fulfill them. All life insurers are held to extremely high standards and requirements for maintaining adequate reserves and capital surpluses. But, some companies do a better job of meeting or exceeding those standards, and consequently, they receive higher ratings from the independent ratings agencies. To give you an idea of how these ratings distinguish one level of financial strength from another, consider the ratings guide from A.M. Best:

A company with an ‘A” rating has demonstrated excellent performance and has a very strong ability to meet its obligations over a long period of time. Compared with:

A company with a “B” rating has an adequate overall performance and can meet its obligations…but it may be vulnerable to unfavorable changes in underwriting or economic conditions.

No one can predict the future, but one thing is certain, and that is there will economic downturns, maybe even another meltdown such as we experienced a few years ago. When the more highly rated companies can come up with annuity products that are just as competitive as a lesser rated company, why would you choose the lower rated company. With an investment that depends on the guarantees and performance of its issuers, it best to stick with the best.

What Type of Annuities Are There

Despite the security they have provided for millions of people for nearly a century, annuities were once thought to be stodgy and boring investments, nothing more than an interest bearing savings account with some guarantees and tax advantages. They’re issued by life insurance companies, and what can more boring than that? Well, for the last half of a century, life insurers have been cooking up smorgasbord of annuity products that has catapulted them to the height of popularity and controversy. Presently, with hundreds of products available, there’s likely to be one type of annuity for just about any long term investor. The number of choices can be overwhelming if not downright paralyzing. We break it down for you here so you can more quickly find the right annuity product for you.

Essentially, there are two primary types of annuities: immediate and deferred. Within these two broad categories you will find a number of variations which expands the number of different types of annuities. With each iteration and innovation of a new type of annuity, their complexity increases. For a better understanding of how even the most complex annuity product works, its best to start at the top of hierarchy with the most basic versions.

Immediate Annuities

Also referred to as life annuities, income annuities, single premium immediate annuities, these are based on the original concept of annuities introduced centuries ago. At their simplest, annuities were conceived as a straight exchange of capital for a stream of income. Citizens in the ancient world would hand over their life savings to the government in exchange for a guaranteed annual stipend. It was a way for governments to fund their armies and infrastructure projects.

Nowadays, immediate annuities are issued as contracts by life insurance companies who use your money to make investments from which they apply a portion of their return to your own annuity account. They then calculate how much income your principal deposit will generate over a specified period of time when it is paid out as a combination of a return of principal and interest. For people who seek a secure income they can’t outlive, the life insurer guarantees income payments for life, even if you live beyond your life expectancy. In essence, they underwrite your longevity risk.

Deferred Annuities

At one point, way back when, life insurers begin to recognize that most people didn’t have lump sums of capital to convert to income, so they added an accumulation component to their annuities. This enabled people to “defer” their income payments until such a time that they had accumulated sufficient capital. The accumulation component, or phase, of the annuity contract consists of an individual account to which the life insurer credits an annual interest payment. To discourage people from using their deferred annuity as liquid savings account, they instituted a surrender fee schedule which applies a charge to withdrawals that exceed 10% of the account’s value. The fees start out high (7 to 12 percent) and then decline by a percentage point each year until they vanish.

In the 1940’s, the U.S. government recognized the value of annuities as a retirement savings vehicle so it conferred upon them a favorable tax treatment, similar to qualified retirement plans, that allowed savers to defer taxes on earnings inside the contract. This made annuities a very popular choice for savers in the higher tax brackets, especially when the tax rates were as high as 70%. The earnings are eventually taxed upon withdrawal, plus, withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty.

At any point, a deferred annuity can be converted to an immediate annuity for guaranteed monthly payments. Once that is done, the principal balance is irrevocably turned over to the life insurer.

Have it Your Way

With the basic components of plain vanilla annuities well established – accumulation accounts, minimum rate guarantees, tax deferred earnings, guaranteed death benefit, guaranteed income – the life insurers began to add new flavors to attract investors of all stripes. It began with the introduction of variable annuities in the 1950’s and grew from there.

Variable Annuities

Essentially, variable annuities replaced the interest bearing accumulation account with separately managed investment accounts that enabled investors to allocate their funds among stocks, bonds and fixed vehicles. Unlike a fixed deferred annuity in which the account funds are invested in the insurer’s general account, these accounts are separate and the earnings are generated from the investments within them. Investors have the ability to transfer, free of taxes, between the accounts. Like mutual funds, variable annuities incur investment management expenses which are passed on to the investor.

Although they were an investor favorite during the roaring markets of the 1980s and 1990s, variable annuities came under criticism for their high expenses. They also became controversial when annuity salespeople began to target older people for whom these products with market risk, high expenses and high surrender fees may not be appropriate. More recently, insurers have been adding more guarantees, such as minimum withdrawals and minimum interest rates, which address the market risk concerns. While these guarantees increase the expenses, they make variable annuities much more palatable for risk adverse investors.

Indexed Annuities

With roaring markets comes volatility, and many investors, while they might like the upside potential, lose sleep with the wide fluctuations in the markets. So, insurers came up with a product that offers market-like returns in good markets while protecting the principal against downside movements. Indexed annuities are more like fixed annuities in that their yield is fixed for a year, however, the amount of the yield is based on the percentage gain in a stock index. When the stock index experiences a year-over-year gain, the insure credits a portion of that gain to the annuity account. In periods when the index declines, the insurer credits a minimum interest rate. It can be an ideal investment for people who want to earn more on their funds than a straight fixed yield, but can’t tolerate the up and down fluctuation of returns in the stock market.

Variable and Indexed Income Annuities

Both of these annuity variations also offer the opportunity to convert the accumulation accounts into income. The amount of the income payment is linked to the performance of the underlying investment accounts, or, in the case of an indexed annuity, a stock index. This can be ideal for people who want some portion of their income to have growth potential. And, with the added protections these annuities offer through guarantee options (at a cost), investors can achieve income growth with peace-of-mind.

Annuity Investment Advice

When considering any type of investment it should be placed in the context of an overall investment strategy based on your financial profile. Annuities, especially, need to be viewed as a component of an asset allocation that includes a mix of investments that can provide the greatest amount of diversification and balance in order to reduce risk and produce stable returns. Only then can you determine whether any investment choice is suitable for your situation.

When viewed in this way, annuities need to be considered for the role they can play in the overall investment strategy and how they help maintain the balance in a portfolio while enhancing its return or reducing its risk. They have certain investment characteristics that need to matched your own investment preferences, tax situation, tolerance for risk and your need for liquidity.

Defining Your Investment Objectives and Financial Profile

Before any investment product can be evaluated for suitability, you need to have your investment objectives clearly defined with quantifiable benchmarks. This includes defining the goal, how much needs to be accumulated, and the time horizon. With that, you can calculate what kind of return you will need to achieve in order to meet your objectives. Aggressive goals with shorter time horizons will require a higher rate of return commensurate with a higher level of risk. Long-term goals may require a lower return and less risk. It is important to prioritize your objectives because it’s not always possible to achieve all of them. You will need to focus on your most essential objectives until you have the capacity to include more objectives in your plan.

Next, you need to apply your particular investment preferences and risk tolerance. The younger you are, the more risk you may be able to tolerate. You have the value of time to help you smooth out the ups and downs of the market. If you’re older, you may not have as long a time horizon, therefore, you may not be able to tolerate as much fluctuation in your portfolio value. In all cases, it is important to weigh your tolerance for all kinds of risk. You may not like market risk, but if you don’t have any exposure to the stock market your portfolio returns may not be able to counter the risk of inflation. You may prefer fixed income investment or bonds over stocks, but you then have to deal with interest rate risk. The best way to minimize risk is to seek a balance in your assets that will act as counter weights to all types of risk.

Next, you need to consider your tax situation and your need for liquidity. If you are in the higher tax brackets, you can benefit from tax advantaged investments. And, if you sufficient liquidity, that is asset that can be converted to cash without risk to their value, you can afford longer term investments that may require a minimum holding period, but offer greater potential for returns, such as real estate or variable annuities.

Annuities as part of Asset Allocation

Annuities can play several roles in asset allocation by increasing diversification, adding balance, lowering taxes, or adding stability. Here are a few ways annuities add value to an allocation:

Fixed Annuities:

For portfolios heavily weighted in stocks with widely fluctuating returns, fixed or indexed annuities can stabilize the portfolio so that, in periods when the markets are declining, the portfolio is still earning a return. And, if the portfolio is heavily taxed, annuities can reduce the portfolio’s exposure to taxes.

Variable Annuities:

For portfolios that lean towards fixed investment of interest-bearing investments, variable annuities can add a much needed boost in returns without substantially increasing the total risk exposure of the portfolio. Although they are considered to be an equities investment, many variable annuities today offer downside protections in the form of guaranteed death benefits, minimum guaranteed rates of return and account reset features.

Immediate Annuities:

For portfolios generating income, immediate annuities, with their fixed guaranteed income streams, can add stability allowing for the portfolio to maintain some exposure to stocks and other investments that can produce increasing amounts of income, but that are subject to market fluctuations.

Liquidity Needs

In all cases, the need for portfolio liquidity needs to be considered. Annuities are viewed as long-term investments, and, although they have fairly flexible withdrawal provisions, their benefits can only be maximized through a long holding period. Unless, you have a sizable portion of your assets invested in cash and cash equivalents, you may want to hold off on investing in an annuity. Also, you need to be mindful that annuity withdrawals are taxed as ordinary income rates. The longer you can defer withdrawals, the more the tax deferred growth of annuity will benefit your portfolio. Withdrawals made prior to age 59 1/2 may be penalized by the IRS, so you need to consider your current age when evaluating an annuity investment.

If you annuitize an annuity, converting it into a stream of income guaranteed by the life insurer, you give up your rights to your principal. So, it would be important to have sufficient liquidity among the other assets in your portfolio.

Summary

There is no one investment vehicle that is suitable for everyone. But, when placed in the context of an overall asset allocation strategy, many investments can play a vital role in adding diversification, balance, tax efficiency, or stability which is the way to ensure steady, consistent returns over the long term. Annuities, with their guarantees and tax advantages can play a unique role in asset allocation. It is important to evaluate annuities not as a standalone investment, but, rather as a component of your overall strategy. In order to do that, you will need to have a clear understanding of your investment objectives and your personal financial profile.

What are SPIA Annuities?

Very few investment vehicles can trace their lineage back to the days of the Roman Empire. Gold comes to mind, but back then it was used as a currency. Annuities are as old as some hills, and they have been providing people with financial security for centuries. They were derived from a simple financial arrangement that involved an exchange of money for a stream of annual payments, or stipends as they were known way back when. Now, annuities are a product issued by life insurers that have formalized the concept into contracts. The same type of annuities that secured the families of Roman citizens are now referred to as Single Premium Immediate Annuities (SPIA), but they are designed to achieve the same thing for people today.

The basic concept of SPIA has never really changed. Throughout history, people have been concerned with securing an income that they can’t outlive. Today, an increasing number of people are growing anxious over the capacity of their own assets to generate a stable income during ever expanding life spans. As a result sales of SPIAs have increased dramatically as have the number of products being offered in the marketplace. The vast number of choices can be perplexing, but once SPIA annuities are explained it is little easier to find the right annuity product.

The Mechanics of SPIA Annuities

It’s a straightforward transaction. In exchange for a lump sum of capital, a life insurer promises make income payments based on the amount of the lump sum, the age of the individual, the length of the payment period and an assumed amount of interest credited to the annuity balance. The length of the payment period can be based on a specific number of years or on the life expectancy of the individual. In the case of the latter, the number of payment periods is calculated by subtracting the current age from the age at expectancy, and then dividing it by 12 (for monthly payments). The amount of the payment is derived by dividing the lump sum of capital by the number of payment periods and then factoring in interest accumulation over the total payment periods.

The income payout is calculated to deplete the total capital along with interest credited by the end of the payment period at which signifies the end of the life insurer’s obligation. The exception is when a lifetime income option is selected, which means that the income payments will continue beyond life expectancy for as long as the recipient lives. In that instance, the life insurer assumes the risk of life longevity. It is that aspect of SPIAs that makes them so compelling to retirees – no more fear of outliving one’s income.

Things to Know about SPIA Annuities

Deposits are irrevocable:

Once a lump sum of capital is deposited with a life insurer, it is irrevocably retained by the insurer. This occurs because the insurer is required to commit the capital to investment so it can generate the promised payout. So, it is obviously important that the decision to invest in an SPIA is based on sound planning.

SPIAs offer several payout options

: The simplest annuity arrangement is called “life only”, which applies when an annuitant has no need to have the income continue beyond his life. So, once the annuitant dies, the income stops, and the life insurer retains the balance of the annuity account.
When there is a need for continuing income, a joint life payout option can be chosen which provides for the continuation of income to the surviving person. The initial payout on a joint life option is lower than that on a life only option to compensate the life insurer for the longevity risk of the joint annuitant.

Additionally, where there is a need or desire to have a beneficiary receive the annuity account balance (as opposed to having it retained by the life insurer), a refund payout option can be chosen. In this instance, after the death of the annuitant (or both annuitants in the cases of joint life option) any remaining annuity balance is paid to a beneficiary in installments over a specified period of time, typically five years. Again, there is an added cost for this option which Is deducted from the initial life only payout amount.

SPIAs offer inflation protection

: One of the criticisms of SPIAs has been that they only provide a fixed level of income which would become inadequate over time due to the rising cost of living. Most SPIAs offer an inflation protection option which will link the income payout to a cost-of-living index so the income will be adjusted each year.

The income guarantee is backed by the strength of the life insurer

: A distinguishing feature of SPIAs is that the income payment is guaranteed which brings a lot of comfort to retirees who are distressed over economic uncertainty. It is important to be mindful that the guarantee is only as solid as the life insurance company that backs it. While the life insurance industry as a whole is considered to be the most financially stable of all financial institutions, some companies within the industry are measured as being much stronger than others. Companies that earn the highest ratings from the ratings agencies are deemed to be strong enough to weather the worst of economic storms, while lower rated companies are viewed as suspect in their ability to pay future obligations.

SPIAs can be used in a number of situations

: While SPIAs are thought of as primarily a retirement income vehicle, they are used in a wide number of situations where a lump sum of capital needs to be converted into a fixed number of installments or payments. SPIAs are used in legal settlements, lottery payouts, and by businesses in buyout situations. Grandparents have been known to purchase an SPIA that will payout an income for a grandchild to cover college expenses.

Summary

They may be ancient, but they have never been more timely. SPIAs are bringing much needed peace-of-mind to anxious retirees who have lost confidence in the markets and their own capacity to generate enough income for their retirement security. When used in concert with other investments, SPIAs provide the stability a portfolio needs to withstand volatile markets and economic uncertainty.

Tax Advantages of Annuities Explained

Annuities have long been the investment of choice for people seeking safe, stable returns and a guaranteed stream of income for life. Their popularity exploded, though, once the Internal Revenue Code established their favorable tax treatment. Since then, the popularity of annuities has correlated with the rise and fall of the tax rates. Their popularity reached its zenith in the 1980’s when top tax bracket was 70% and interest rates had climbed to astronomical heights. The notion that one could earn double digit returns, without risk while not paying taxes on them held mass appeal for many investors whose income tax rates exceeded 50%. It was like earning an instant 50% return on their investment. It was hard to do better than that.

The Advantage of Tax Deferral

Since then, tax rates and interest rates have fallen significantly. But, the tax advantages of annuities are still attractive enough for investors who want to maximize their returns by minimizing their taxes. The top federal tax rate today is 35%, but when you add in state taxes, investors can still be subject to a combined tax rate as high as 47%. That means for every dollar they earn, they currently save 47 cents in taxes. Annuity earnings are eventually taxed as ordinary income when they are withdrawn, so the tax savings are only temporary. But, what tax deferral does for investment earnings is it lets them accumulate unencumbered by taxes enabling them to compound much faster than if the taxes were paid on them when they are earned. When the “miracle of compounding interest” is combined with tax deferral, the long term results can be overwhelming.

Take for example a hypothetical $10,000 investment that returns a steady 6% return. For someone in a combined tax bracket of 40% the total growth of the account would amount to $40,817 over 30 years. In a tax deferred account, it would grow to $57,435.

Tax Flexibility

Eventually taxes on annuity earnings have to be paid. But, at least you can control when and how that happens. For many people, the first withdrawals they take would occur in retirement. The expectation of most people is that they will be in a lower tax bracket in retirement. If they were in the higher brackets during their peak earning years, they could see their tax rate drop significantly depending on the amount of income and its source. If they have multiple sources of income, they can choose when to take withdrawals from their annuity based on their tax situation at a given time. If they have other sources of income, they could allow their annuity earnings to accumulate and defer taxed further into the future.

Making Tax Deferral Last

For retirees interested in getting the maximum income from their annuities while deferring taxes as far as they can go, they could convert their deferred annuity into an immediate annuity. A key tax advantage of immediate annuities explained is the return of principal component of the income payment. Essentially, when a lump sum of capital is converted into an income annuity, the payments from the life insurance company consist of both a return of principal and interest earned on the principal. So, taxes will only be owed on the interest portion. The income payments are calculated based on a total depletion of the principal and interest earned over the specified payment periods, or, in the case of a lifetime annuity for the life of the annuitant. So, for a good portion of the annuity earnings, taxes can be deferred for many years.

Summary

For a non-qualified investment, annuities have a unique tax advantage with their tax deferral. Contributions to annuities are made with after-tax dollars, as opposed to pre-tax dollars for qualified retirement accounts. However, there is no limit to the amount of contributions made to annuities as there are with qualified plans. For people with the capacity to save for retirement beyond their qualified plan contributions, an annuity is the next best thing for achieving tax favored growth of earning. And, with the availability of growth oriented annuities, such as variable or indexed annuities, investors who seek the greatest amount of diversification and growth opportunities, can realize higher tax favored returns.

It is always advisable to seek the guidance of a qualified tax professional when considering the tax aspect of annuities. And, for optimum planning for retirement or for the disposition of your estate, it is recommended that you seek the counsel of qualified financial advisors for the best understanding of how annuities will work in your particular situation.