Ken Nuss

is an option available with some fixed-rate deferred annuities. Also called a multi-year guarantee annuity or MYGA, this product acts much like a bank certificate of deposit. You deposit a lump sum and get a guaranteed interest rate for a set period, usually two to 10 years. Interest reinvested and compounded within a nonqualified annuity is tax-deferred.

However, if you cash in your annuity early, during the surrender period, you’ll pay an early surrender charge, which typically decreases each year—and thus the reason for this rider.

The ROP rider guarantees that you will not receive less than the premium deposit you made from day one, even after early surrender charges and market-value adjustments. You get flexibility should life throw you a curveball and you need all your money back.

If you choose this option, you will usually get a slightly lower interest rate. For instance, one insurer offers a five-year annuity that as of October 2022 pays 4.95% without the rider and 4.70% with it.

Before you commit, find out how much in penalty-free partial withdrawals the annuity would allow. If they’re generous enough, you may not need this option.

Three options for fixed indexed annuities

Fixed indexed annuities let you get a portion of the stock market’s gains while offering complete protection from loss. They credit interest based on the annual growth of a market index, such as the Dow Jones Industrial Average or S&P 500. You lose nothing in down years.

Depending on market performance and the annuity contract, you may not get all of the upside during an up year. That’s because there’s usually either a set cap rate, for example, no more than an 11 percent increase in a given year, or a participation rate, such as no more than 60% of the index gain in a policy year.

. With some fixed indexed annuities, you can buy a higher index cap rate or participation rate by paying a small annual fee for it, often around 1.00% to 1.50% of allocated assets annually. If the amount of extra interest earned as a result of the higher cap or participation rate exceeds the fee charged, then it was a winning decision. If you’re optimistic about the stock market over the long term, consider this option.

 typically creates a separate death benefit value that increases at a guaranteed higher annual rate than may be experienced with the actual account value for a certain number of years. Upon the death of the annuity owner, the beneficiary gets the higher of the two values.

Typically, a small annual fee is charged. For example, one insurer charges 1.15% of assets, which is deducted from the account value. If you want to leave more money to your children, this rider may be worth adding.

. This helps generate more guaranteed lifetime income at a future date while still giving you complete control over the money in your indexed annuity. Since you don’t set the date in advance for income payments to start when you buy the annuity, you retain planning flexibility. You can choose to start receiving lifetime income, typically beginning at age 55 or later, for just yourself or you and your spouse.

Normally, when you convert any annuity into an income stream, (“annuitization”), its cash surrender value becomes zero. But with this rider, you still own the full unused value of your annuity. A huge advantage, but there are downsides.

Most insurers charge around 1% annually of the assets in the annuity to add an income rider. So, your contract value will grow more slowly than without the rider.

The lifetime income amount is determined by the income account value and your gender and age at the time you start receiving payments. The income account value typically grows at a guaranteed annual compounded rate of 4 to 8 percent, so the longer you wait until you start taking payments, the greater the income.

The income account value and cash value of your contract are separate. The income account value is used only to calculate your guaranteed income payments. It has no cash value and cannot be withdrawn. In contrast, the contract value can be withdrawn or passed to your heirs.

After income starts, annual payments are deducted from the contract value. If that value ever reaches zero, annual income payments are still guaranteed for the remainder of your lifetime, but the annuity would no longer have any cash surrender value.

If you die before income activation, your beneficiaries will receive the full annuity contract value as a death benefit. If you die after income activation, the income payments will cease and your beneficiaries will receive any remaining annuity contract value.

Lifetime income riders vary dramatically among annuity companies. AnnuityAdvantage’s Income Rider Calculator page provides an instant estimate of the future income you could expect from a lump sum premium deposit.

All four add-ons covered in this article are optional.

Even without one, you’ll still have the powerful advantages of an annuity. Sometimes, however, paying the additional fee for a rider or feature can be a smart move.

Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and lifetime income annuities. Ken is a nationally recognized annuity expert and widely published author. A free rate comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com or by calling (800) 239-0356.

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Annuity myths are harmful because they lead people to dismiss annuities out of hand when they could be a perfect fit.

Myth 1: Annuities are all the same. They’re good only for retirees.

Fact: Different types of annuities are distinct and can help a range of people achieve their financial goals.

Deferred annuities help you build wealth through tax deferral

. They include CD-like fixed-rate annuities, fixed-index annuities that offer growth potential without the downside, and variable annuities, which resemble mutual funds with tax deferral. Earnings left to grow and compound in the annuity are tax-deferred.

provide a guaranteed stream of income for a set period or life. 

A lifetime payout annuity is the only financial product that guarantees income for life. Once payments begin, income annuities usually have no cash surrender value.

Despite their diversity, annuities aren’t suitable for everyone. If you withdraw or receive earnings from an annuity before age 59½, you’ll be hit with a 10% IRS penalty along with regular income tax.

Because the annuity market is very competitive, insurers that don’t offer good deals won’t attract many customers.

Variable annuities do have ongoing fees that are deducted from the contract value, and fees sometimes are high. Morningstar Annuity Research Center says annual fees average 1.10% but can go much lower or higher. You can avoid pricier offerings because fees are clearly disclosed in the prospectus.

 consumer fees unless you choose optional rider(s). There’s no sales charge; all the money you deposit goes to work immediately.

The fact that fixed-rate annuities usually pay significantly more than bank CDs with the same term shows that they offer good value. Rates have increased recently.

Income annuities from different insurers produce different amounts of income. To make sure you’re getting the best deal, work with a competent annuity agent who’ll shop the market and give you comparisons from multiple insurers.

Myth 3: Annuities aren’t suitable for IRAs.

Fact: Most types can work well as a traditional or a Roth IRA.

This is one of the biggest myths. One or more types of annuities can be a great choice for IRAs.

A fixed-rate annuity can be a great choice for IRA assets you want to shelter from market risk and earn a set rate of interest. It has a significant advantage over bond funds because they guarantee your principal.

A fixed-index annuity also guarantees principal. It can offer potentially higher rates of long-term return if you don’t mind a fluctuating interest rate.

An income annuity can work well as a traditional IRA. However, your income payments must begin no later than age 72 to comply with required minimum distribution (RMD) rules. If you want to defer distributions past that age, consider a qualified longevity annuity contract (QLAC). It’s a type of income annuity that lets you delay RMDs up to age 85. You can invest up to 25% of your IRA money, to a maximum of $145,000, in a QLAC.

, you can get guaranteed tax-free income for life. Depending on how soon you need income, you can choose an immediate or deferred income annuity.

With the joint-income option, your spouse will receive regular monthly income payments for the remainder of his or her life too. Payments to a surviving spouse are always tax-free, assuming your spouse was the sole beneficiary or your ROTH IRA.

If, however, you want to use your Roth IRA to pass wealth to your children or grandchildren, an income annuity probably isn’t the best choice.

In my opinion, variable annuities aren’t usually a good choice for traditional or Roth IRAs, since you’re paying additional annuity-related fees for tax deferral you already have in an IRA.

Myth 4: Annuities are rip-offs because of early-surrender charges.

Fact: These charges are easily avoidable. Furthermore, most annuities provide some liquidity and flexibility during the surrender period.

If you keep your annuity for the full term, you won’t be hit with an early-surrender charge. If you’re concerned about the length of the surrender period, look for an annuity with a shorter period.

What if you unexpectedly need your money during the surrender period?

First, most deferred annuities let you take a partial withdrawal, typically up to 10 percent of the accumulation value each year, without penalty. Second, you can usually annuitize the contract—turn it into a stream of income—without penalty.

Today, some income annuities let you take out a partial withdrawal before (and in rarer cases after) income payments start. The insurer may also allow you to move up the date for payments.A cash-back option will reimburse your beneficiary if you die before the annuity has repaid your entire premium.

Annuities are meant for money you can afford to set aside for a while and won’t need until 59½. If that doesn’t apply to you, an annuity won’t be a good choice.

Myth 5: Once you buy an annuity, you’re stuck with it.

Fact: There’s a “free-look” period.

Most states require a free-look period that lasts for the first 10 to 30 days after receipt of the annuity policy. If your circumstances have changed or you’ve found a better deal, you can cancel the contract and the insurer will return all your money. You won’t, however, earn any interest on the canceled policy.

While it’s unlikely you’ll use the free-look provision, it provides peace of mind.And occasionally, it can be valuable.

Ken Nuss

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