To say annuities can be confusing is an understatement. There is no universal answer to whether an annuity is a good fit for your financial goals. It’s a personal decision and understanding how the contracts work is important. Whether you have an annuity or might buy one, here are seven questions you’ll want answered. 

What Are My Fees?

The first step with understanding your annuity is to know what you are paying and what you are receiving for that money. There are a variety of fees depending on the type of contract. With a fixed annuity, none of these might be applicable, and with some forms of variable annuity where the return is based on contractual range, none or only some of these might be incurred. And in others, all of them could be fees you pay out of the contract value.

• Mortality & Expense Fee: Sometimes listed as an administration fee called M&E or ME&A, this fee is basically for the insurance company to administer the contract to you and cover their risks and costs.
• Subaccounts: To investors, they appear similar to mutual funds and are baskets of investments based on criteria like an asset class or type. There is an expense ratio inside these for investing the funds according to their objective.
• Income and Death Benefits Riders: These will be explained below, however, they typically come with their own fee to deliver a contractual plan for income or value upon death, depending on the situation.

Ranges for these fees can be difficult to estimate, however, it’s safe to say that if you have a traditional variable annuity with the ME&A, plus an income rider and a series of subaccounts, they will all likely total something more than other forms of investing, like index funds or ETFs. However, you also have to consider the contractual benefits being received. 

What Is the Surrender Charge Schedule?

When signing up for an annuity, in addition to agreeing to some combination of the fees above, you probably are also agreeing to leave your money in the contract for a particular period of time. This is called a surrender charge schedule. Not all contracts come with them, though—some (but not many) contracts are liquid from day one. For others, the timeframe could be three years all the way up to 10 or more years, with a charge if you take more than what’s referred to as the free amount, which is typically 10%. 

Now, not having access to all your money at once is inherently a disadvantage, but on the other hand, as long as you understand the timeframe you are entering into and using funds you believe you’re unlikely to need large portions of, perhaps it isn’t an issue. For example, these may be IRA funds you are investing and therefore don’t intend any large withdrawals until retirement. If you already own this contract or are considering it, mark the calendar in a memorable way so you can be reminded when your contract reaches its liquidity date. You might not change anything or withdraw all your funds, but it is a milestone and opens additional options for your financials going forward.

Who Is Your Point of Contact?

Sometimes when you have a negative experience with annuities, it isn’t necessarily how the contract works, it’s the person who sold you the annuity—or possibly the lack of that person remaining available and attentive. An annuity generally works better when there is a professional involved from start to finish, not just at the beginning, and then you are left to figure out how to maximize the benefits on your own.

Before purchasing an annuity, ask questions like, “Who will be my point of contact on this? What happens if that person leaves? What is the customer service number directly to the insurance company?” This allows you to continually have a way of asking questions.

If either your original point of contact becomes unresponsive, or life events occur (like you move out of state), it is possible—although not always easy—to find a new point of contact for an existing account. What you would do in that situation is locate a new financial advisor or professional who is licensed to service annuity contracts in your state and ask them if they will agree to service and explain the contract going forward. This is called a change of representative and requires paperwork. If you find someone new who is attentive and helpful, however, it can go a long way toward having the annuity do what it’s supposed to do. 

What Taxes Do I Need to Be Aware of with Annuities?

Annuities are not a single type of account that is taxed in a uniform way by the IRS; it depends on the tax structure you bring to the annuity. Much like saying you bought a vehicle from a particular major car brand, that vehicle may be a gas-efficient hybrid sedan or a gas-guzzling SUV.

Using funds that are currently in an IRA to fund the annuity would dictate that all withdrawals—whether it’s principal or gain—are taxed as income. In the opposite circumstance, if you have a Roth IRA annuity, then provided the rules are followed, withdrawals would be tax-free. The third scenario would be funding an annuity with money that is not one of these, commonly referred to as a non-qualified contract. For example, if you own it individually outside an IRA, or jointly with another person, or inside of a trust. In all these cases, you would have what’s called basis, meaning your original deposit. If the contract makes money, then that is considered your gain, which is not taxed until you withdraw it, and is taxed first. 

Making up numbers as an example, let’s say you deposit $200,000. When you take your first withdrawal, it is worth $220,000, so everything you take up to that $20,000 gain is considered income. With the recurring theme of annuities being complicated, knowing this $200,000 figure is not always easy—especially in cases where one annuity has moved over to another one, called a 1035 exchange. The cost basis is supposed to transfer with the money, but that information isn’t obviously stored and visible on your statements or provided to you. If you think you own a non-qualified contract, it’s helpful for planning purposes to contact that company and ask them what your cost basis is and store that for later when you start taking withdrawals. 

How Does the Money in an Annuity Grow?

Contrary to what might be assumed about annuities, it’s fairly common that people deposit funds into one without any immediate need for income—or possibly never need any of its income. It can be an alternative method of trying to grow your assets for later or future generations. The possibilities could be their own article entirely, but the question pertains to your contract. Ask the vendor or your point of contact, “What would cause my money to grow or fall in value?”

How Does Annuity Income Work?

There can be multiple ways one can access the funds from the same annuity, and each have different consequences for its long-term value. You can annuitize the balance, meaning turn it into an irrevocable monthly payment—which is actually a relatively rare form of income—or simply take withdrawals as necessary and pass on any remaining balance.

Beyond these methods, there are also what are called income riders. These are arrangements to determine what the eligible income might be at points in the future, separate from how the underlying money performs. How the future income amounts are determined and what can cause them to change are important retirement planning items. If the income rider isn’t being explained clearly or makes it sound too good to be true, you might want to get a second opinion.

What Is a Death Benefit Rider?

Put simply: riders that change how the death benefit works on a contract. These riders can cause the death benefit to be something other than simply what’s left of the money at the time of passing. Questions around death benefits can be important for planning purposes, such as:

• How does the death benefit grow?
• What is the cost for this rider or feature?
• What happens to this alternative death benefit value if I take withdrawals?
• Does this death benefit rider stop being a benefit at a particular age, like 80 or 85?

If you have more questions about the annuity you own or are being presented, don’t worry; you are not alone. They are certainly complicated instruments that benefit from working with a patient and knowledgeable financial advisor. Ask the questions you need, and you can use that information to plan for the best circumstances available.

Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.

Riders are additional guarantee options that are available to an annuity or life insurance contract holder. While some riders are part of an existing contract, many others may carry additional fees, charges and restrictions, and the policy holder should review their contract carefully before purchasing.