Annuities 101 | SJS Investment Services

Annuities 101

March 14, 2016

If you were to ask one hundred investors to describe or explain an annuity, you would likely get nearly one hundred different answers – some of them accurate, and others probably less so.

“Annuities are among the most bought, least understood” financial products, says Tim Maurer, of CNBC. One of the most common questions I hear from clients is, “What is an annuity, and how does it work?” When it comes to annuities, there are many, often complex, options out there, and it’s easy to understand the confusion. So how can you tell if an annuity is a good option for you?

First, the basics: annuities are long-term investments created by insurance companies and designed to help you achieve retirement or other long-term goals. Annuities provide the benefit of tax-deferred growth of earnings while your funds remain invested within the annuity.

Annuities may come with drawbacks, however. In general, all annuities lack liquidity and carry significant surrender charge penalties – which can be as high as 20%, and last for more than 15 years – should you decide to withdraw your money before your set term is up. Regardless of when you withdraw, all gains are taxed at ordinary income tax rates, not as capital gains.

There are three main types of annuities: fixed, variable, and equity-indexed, with variable annuities being the most common. Here is a quick overview of each type:


Fixed annuities can be described as similar to a bank-issued CD. A fixed annuity pays you a guaranteed rate of interest for a set term.

Advantage: A fixed annuity may be an appealing choice if you are an investor who is cautious about the market’s ups and downs.

Disadvantage: If you choose to invest using a fixed annuity for an extended period of time, you could find that the rates do not keep pace with inflation or other comparable investments.


Variable annuities allow you to select how your money is invested within the available subaccounts, which are investments similar to mutual funds. During your retirement years, you may be able to convert the annuity value into a stream of income, which is determined by the performance of your investments.

Advantage: A variable annuity allows you to invest in stock and bond mutual funds, offering you an opportunity to earn a greater return.

Disadvantage: Variable annuities often have very high fees. Ongoing administrative, insurance, and management fees can add up to as high as 2% to 3% annually. Combine these costs with rider fees, and the annual costs can easily exceed 3% per year. There is also more risk associated with the investments, which can cause the value of your annuity to decline.


This type of annuity is a combination of a fixed and the variable annuity. As with fixed annuities, your account comes with a guarantee of your principal.

Advantage: Your account return will be tied to the performance of a benchmark index; therefore, you have a chance to earn a greater return if your benchmark goes up.

Disadvantage: Equity-indexed annuities are typically very complex and come in a wide variety of forms.Because there are so many different versions and moving parts, the formulas and index participation rates can be difficult to understand.

For all three types of annuities, there are a number of options for converting the annuity value to a stream of payments, including lifetime payments, or payments for a specific period of time. This is called “annuitizing.” The ability to convert the annuity to these payments can help alleviate the fear that you may outlive your assets.

Additionally, you can typically purchase separate “riders” or options that pertain to withdrawal benefits and death benefits. These riders can vary from one annuity to another, or even from one insurance company to another. There are many, many payout options available, which can increase the complexity and lead to confusion.

Here at SJS, we understand that your future is important, and we know that annuity investments can be complicated, as there are so many variations available. It is important to understand what is guaranteed along with the rules to reap the potential benefits of annuities. Although we do not typically offer annuities as a primary investment tool because of their complexity and cost, we can help you evaluate any annuity you may already own. There may be more tax-efficient and less expensive ways to achieve the same outcome you’re seeking. We’ll be here every step of the way to help you determine the best options to reach your desired investment goals.

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