Planning for retirement: What is an annuity?

This week is National Plan for Retirement Week. Some people use annuities as part of a retirement strategy because they can provide a steady income after retirement, but they can be confusing.

Annuity basics
An annuity is a contract in which an insurance company agrees to make a series of payments in return for a premium (or premiums) that you have paid. Many consumers buy annuities to have a regular income after they retire. An annuity is an investment and shouldn’t be used to reach a short-term financial goal.

How annuities work

• You pay either one premium or make payments for a set period of time in exchange for future income.
• Annuities should increase in value over time and income taxes are deferred until you withdraw dividends. People who withdraw money before age age 59½ can be subject to a 10 percent income tax penalty
• You can request to receive payments in a lump sum or in periodic fixed amounts.
• A popular payout option is "lifetime income with 10 years certain." This means the annuity pays a monthly income for the life of the annuitant or for 10 years, whichever is longer.
• Annuities also pay a death benefit.

There are three types of annuities:

• Fixed annuities: Your money - minus any applicable charges - earns interest at rates set by the insurer, as specified in the annuity contract.
• Variable annuities: The insurer invests your money - minus any applicable charges - in a separate account. The company invests your money in stocks, bonds or other investment funds you choose, based upon how much you're willing to risk. If the fund doesn't do well, you may lose some or all of your investment.
• Equity-indexed annuities: The insurer offers a guaranteed minimum return, plus it offers a variable rate based on the return of a specific index. During the accumulation period, the insurer credits you with a return based on interest earned plus or minus changes in the index, subject to participation rates, caps, charges and other restrictions. The most commonly used index is Standard & Poor’s 500 Composite Stock Price Index (S&P 500).

Buying an annuity
Washington state law requires applicants to undergo a suitability analysis before the sale or replacement of any annuity. The analysis includes an evaluation of your financial position, income needs and the cost of liquidating any assets. This can help you determine which annuity is right for you.

As with other major purchases, it’s a good idea to shop around and compare information for similar products from several companies. While you do your research, keep detailed records and get all quotes and key information in writing.

When you are ready to purchase an annuity, carefully review the contract with your agent or broker. Ask for an explanation of anything you don’t understand. Be sure you are aware of all of the terms and conditions such as surrender charges and/or cancellation penalties.

Washington state has a 10-day “free look” period. Washington consumers have 10 days after purchasing an annuity to cancel for a full refund.

Protect yourself
Some insurance agents or brokers use inappropriate sales practices in an attempt to take advantage of uninformed consumers. Red flags include relentless sales pitches that pressure you into buying a product quickly or a deal that seems too good to be true.

The best way to protect yourself is to research the agent and company you’re considering,

• Find out if your agent or broker is licensed to sell insurance in Washington. 
• Agents and brokers who sell variable annuities also must be registered with the Department of Financial Institutions (www.dfi.wa.gov).

More information

• Read more about annuities on our website.
• Our consumer advocates can give you a list of the information your agent or broker should provide before you make a decision about purchasing an annuity. Call us at 1-800-562-6900.
• The National Association of Insurance Commissioners (NAIC) offers free consumer guides about different types of annuities and has a webpage about annuities.