Five common annuity myths

Dispelling myths about annuities can open the door to many unique investment solutions.

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Over the years, annuities have gotten a bad rap as being complex and expensive, the kind of investment only an insurance professional could love. Well, some are, but there is still quite a lot to love in these products—no matter what phase of life you are in—if you know what you need and you shop smart.

For example, annuities can let your money grow tax deferred before and during retirement. You can also buy protection against market losses and outliving your savings—advantages that are unique to annuities. These guarantees1 come with a price, but for some investors the price is worth the peace of mind. The key is knowing what you need, the difference between various types of annuities, and how to shop wisely.

Here we debunk five of the most common myths and misconceptions around annuities, so you can make better decisions about your investment mix.

Myth 1: Annuities are only for retirees.

Reality: Annuities can help savers, too.

While immediate annuities are designed to turn savings into an income stream right away—typically, for retirees, deferred annuities (variable or fixed) are a tax-deferred savings vehicle used by investors to save more for retirement. With a deferred annuity, you can grow your investment tax deferred, then turn it into an income stream at some point in the future. If you have maxed out on contributions to your 401(k), 403(b), other employer-sponsored retirement savings plan, or an IRA, deferred annuities can offer an additional tax-deferred vehicle to help you build wealth.2

You can choose from two types of deferred annuities:

  1. Deferred variable annuities* invest in subaccounts (similar to mutual funds), which fluctuate with the market. You can typically make unlimited3 contributions and control how your investments are allocated among subaccounts. To benefit most from a deferred variable annuity’s tax-deferred savings opportunity, use a low-cost annuity—some products are available for fewer than 50 basis points (0.50%) of your investment annually.4
  2. Deferred fixed annuities include single premium deferred annuities (SPDAs), which are similar to a certificate of deposit (CD). You are guaranteed an interest rate for a specific period of time, typically one to 10 years. These fixed annuities are insured by the issuing insurance company rather than by the FDIC, and investors need to be comfortable not taking withdrawals before age 59 ½.2 “It’s important with any annuity product to make sure you’re investing with a highly rated company,” says Tim Gannon, vice president at Fidelity Investments Life Insurance Company. “A good way to tell is by checking with a rating agency like Standard & Poor’s or Moody’s. These are independent rating agencies that conduct regular reviews of an insurer’s financial strength and ability to pay its contractual obligations.”

For information on how annuities can help savers, read Fidelity Viewpoints: How to invest tax efficiently.

Myth 2: Annuities cost too much.

Reality: Many annuities are low cost. Others offer potentially valuable additional features at higher costs, which you should consider only if you need to address a specific risk.

When it comes time to choosing an annuity, first consider what you need the annuity to do: build savings or create income. Be sure to compare the cost against the value of each additional guarantee, feature, and benefit—and only pay for what you need.

If you need to maximize your tax-deferred savings, choose a low-cost deferred variable annuity. According to Morningstar Annuity Research Center, variable annuity annual fees range widely, from 0.10% to 2.25%, with an industry average of 1.25%.4,5 Of course, you will pay more if you need to address a specific risk with a guarantee, such as a guaranteed living benefit, which provides income or asset protection from down markets.

Generally, variable annuities charge explicit fees, while fixed annuities tend to embed their costs in the interest rate or income payout amount. Focus on finding a competitive payout rate and an insurance company that is reputable and financially sound.

For details on annuity costs, read Fidelity Viewpoints: A shopper’s guide to annuity fees.

Myth 3: There is no point in buying an annuity for income before retirement.

Reality: As you approach retirement, certain annuities can help protect your future income from market volatility, and some annuities can help protect against inflation.

If your retirement is 10 years away or less, you probably worry that a drop in the market could erode the savings you’ve worked hard to accumulate. A relatively new type of annuity may grant you some peace of mind.

When you purchase a deferred income annuity6 (DIA), you select the future date on which your payments will begin, providing guaranteed income for the rest of your life no matter what the market does. Because they are designed to create future income, DIAs provide the greatest advantage if you don’t need to access the money until you reach your selected income start date.

You can lock in a future cash flow that starts on the future date you selected when you purchased the annuity. At age 58, to create a $1,000 monthly lifetime income payment beginning at age 70, you would invest just under $104,900 today. If you waited until you were age 68 to purchase an annuity, you would need to invest more than $176,0007 for the same level of income.

These types of annuities also enable you to plan for inflation by offering a cost-of-living adjustment, known as a COLA. When you purchase the contract and for an additional cost, you can select to have your income increase annually by a percentage, typically 1-5%. This COLA adjustment takes effect after you begin receiving income, but not during the deferral period. Work closely with your financial consultant as you build a comprehensive retirement income plan to determine whether these annuities are appropriate for your personal situation.

For more on deferred income annuities, read Fidelity Viewpoints: Create future retirement income.

Myth 4: I can easily create lifetime income from my retirement accounts.

Reality: Besides Social Security and pensions, only annuities guarantee a stream of income that you can’t outlive.

Because you can’t predict the markets, you can’t be sure that you won’t outlive your investment portfolio. Indeed, our research suggests that to have a high level of confidence that that won’t happen—even if the markets turn bearish just when you retire—you may need to limit your withdrawals to 4% a year, adjusted annually for inflation. With an annuity, however, you enter into a contract with an insurance company to pay a certain amount for the rest of your life, giving you the peace of mind that comes from knowing your income will never run out.

For example, a single premium immediate annuity (SPIA) or a DIA can play that important role in your retirement income plan. A key benefit of SPIAs and DIAs is that they ease money management as you enter your 80s or 90s. That’s because when you invest a lump sum with an insurer today, the insurance company guarantees you will receive a monthly income payment for the rest of your life. No maintenance is required.

“An additional benefit of locking in lifetime income sources is that you can be more aggressive with the rest of your investment portfolio,” observes Roy Benjamin, vice president and actuary at Fidelity Investments Life Insurance Company. “This could give you a larger nest egg to pass on than you might have otherwise.” Just be aware that once you purchase an SPIA or a DIA, you generally lose access to these assets after the “free look” period—a brief period of time immediately after purchasing a contract when you can cancel the contract and have your money refunded.

For more on lifetime annuities, read Viewpoints: Create income that can last a lifetime.

Myth 5: The insurance company gets my money when I die.

Reality: Your beneficiaries can receive payment(s) after you die.

Most deferred annuities are designed to pass the account value on to your heirs.

Income annuities offer options that can also provide for your beneficiaries in some situations. With income annuities, as long as you don’t select the largest payout option of “life only,” you can arrange to have income payments continue on to your beneficiaries if you were to pass away prematurely. Of course, this adds to the cost, but it could be worth the extra price, depending on your situation. Be sure to work with your financial consultant and discuss the beneficiary options available to you for each type of annuity you’re considering.

Bottom line

Annuities can offer flexibility both in how you save for and receive money in retirement. It all comes down to understanding that there are several different types of annuity products, each of which is designed to address a specific need or life stage. And remember, the best way to explore how they might complement your investment strategy is to work with your trusted financial consultant.

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Before investing, consider the investment objectives, risks, charges, and expenses of the annuity and its investment options. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
*Investing in a variable annuity involves risk of loss—investment returns, contract value, and, for variable income annuities, payment amount are not guaranteed and will fluctuate.
1. Annuity guarantees are subject to the claims-paying ability of the issuing insurance company.
2. Withdrawals of taxable amounts from an annuity are subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% IRS penalty.
3. The issuing insurance company reserves the right to limit contributions.
4. Underlying fund fees apply and surrender charges may also apply.
5. Data as of 12/31/2016 for 356 nongroup open variable annuity contracts.
6. Deferred income annuity contracts are irrevocable, have no cash surrender value, and no withdrawals are permitted prior to income start date.
7. Estimates provided through the Guaranteed Income Estimator as of February 21, 2017 for Life with Cash Refund Option selected for the state of Massachusetts. Purchase at male age 58; assumes income begins in 2029 at age 70. Purchase at male age 68; assumes income begins in 2019 at age 70.
Fidelity insurance products are issued by Fidelity Investments Life Insurance Company (FILI), 100 Salem Street, Smithfield, RI 02917, and, in New York, by Empire Fidelity Investments Life Insurance Company®, New York, N.Y. FILI is licensed in all states except New York. Other insurance products available at Fidelity are issued by third-party insurance companies, which are not affiliated with any Fidelity Investments company. A contract’s financial guarantees are subject to the claims-paying ability of the issuing insurance company.
Fidelity Brokerage Services, Member NYSE, SIPC, and/or Fidelity Insurance Agency, Inc., are the distributors.
Fidelity Insurance Specialists are licensed insurance agents.
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