Why Do People Buy Annuities?

There is no specific answer to that question. Why? Because there are various types of annuity products and each insurance company puts a custom brand on each type. That gives a potential investor literally thousands of choices when it comes to annuity purchases.

Product specs are usually pretty simple, so each type of annuity will appeal to an individual depending on that individual's personal situation. First, I'll cover the basic types of annuities and some general guidelines in regards to the pros and cons of each. Then we'll get into a few basic pitfalls that investors will face during the annuity selection process. Sadly, this has more to do with the offering companies and selling agents than it does with the annuities themselves.

The list of annuity products...

Fixed Annuity: Also called a traditional annuity, this is the most basic product on the market and the easiest to understand.

Reasons to buy- Fixed Annuities offer higher interest rates and tax deferral making them a highly beneficial alternative to CDs for cash investors. Also, because of the extreme safety of these products, they are great for people approaching retirement who want to conserve and protect assets while maintaining steady growth.

Things to consider- Annuities are longer term contracts that usually don't offer the same type of short-term holding place as CDs. Free withdrawals do allow for some liquidity but surrender schedules should be closely evaluated and matched against future plans for the invested money. In addition, pre-retirees should realize the trade off you make when choosing safe growth over potential market gains.

Variable Annuity: This product differs significantly from a fixed annuity in that assets within a variable account are invested in a variety of subaccount or mutual funds. That means the assets will fluctuate according to individual fund performance. This gives an investor the potential for greater returns but also possible investment losses. Variable annuities also offer several income guarantees in order to alleviate some concerns in regard to potential market loss.

Reasons to buy- The major selling points for variable annuities are the advantage of tax deferral and guaranteed income. Tax deferral allows compounding interest to have a greater effect on the bottom line and guaranteed income options will enable investors to hedge desired future returns against a presently specified minimum lifetime income.

Things to consider- The advantages of tax deferral are often offset by high fees inside the annuity. Those fees can be limited if you choose to exclude certain riders but that eliminates many of the guarantees that make VAs attractive. IRAs and 401ks also offer tax deferral, so that shouldn't be a factor in deciding whether to purchase an annuity over your retirement account. In regards to guaranteed income, several strategies exist for ensuring higher levels of retirement income than most variable annuities offer. Run the numbers and find a qualified advisor to help.

Equity Indexed Annuity: This is the most complex of all annuity products. EIAs are a hybrid of fixed and variable annuities. That means that these annuities come with a low base guaranteed rate and an upside gain tied to a major market index. Participation and cap rates limit the overall gain for the investor, meaning that the account will be credited with a percentage of the index gain and capped at a maximum rate.

Reasons to buy- Most people really like an opportunity to participate in the returns of the stock market without risking loss of the principle investment. The right equity indexed annuity can allow a person to conserve assets and keep a reasonable expectation of growth as retirement approaches.

Things to consider- Because of the base guarantee, EIAs come with significant fees that should not be overlooked. These are complicated products. Each company has different ways of calculating returns and crediting the base guarantee. Most equity indexed annuities should be avoided but there are a few that will work in certain situations. Absolutely Do Not trust anyone who shows you something that seems to good to be true because it probably is.

As you can see, based on a general list of products and basic contract components, suitability and selection of products can be difficult. This is where the pitfalls come in for today's annuity shopper. Most advisors are naïve when it comes to the products they represent. It takes work and time to really be able to properly analyze an annuity contract.

Because the insurance industry lacks regulation, the door is open for unqualified individuals to sell products that are hard to understand. I don't think there is any malicious intent, just too many people that gloss over the fine print. And that's where the real action is.

In order to tell if an annuity is the right fit, you'll need an expert advisor. In order to purchase an annuity, you'll need a person who sells annuities. It should work out fine when you find someone who can do both.