Annuity Basics

Jackie Bedard
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Attorney, Author, and Founder of Carolina Family Estate Planning

Before we can discuss ways to use annuities for long-term care planning, it’s helpful to understand some basic concepts about what an annuity is and how annuities generally work.

Annuities are a popular financial tool for retirement planning with many using annuities as a “pension substitute.” The idea is that you invest funds with an insurance company via an annuity policy. The policy then promises to pay monthly income payments to you as the policyholder.  Depending on the terms of the annuity policy, the payments may be for a set number of months or years, for your lifetime, or over some other specified period of time (or you may have the option to wait and make a selection in the future).

While it’s a very simplified analogy, think of an annuity as similar to a “reverse” life insurance policy. With a typical life insurance policy, you agree to pay installments (your premiums) to the company over time and the company agrees that if you die, they’ll pay a lump sum (to your family as a death benefit). With an annuity, you’re giving a lump sum to the insurance company and they’re agreeing to pay it back to you in installments either immediately or at a future date.

Immediate vs. Deferred Annuities

With an immediate annuity, as soon as you invest the money in the annuity policy, it begins making payments back to you.

With a deferred annuity, you invest the funds in the annuity policy but you do not yet start to receive income payments—the idea being to let your invested funds grow until you need income at a future date.

Fixed Annuities vs. Variable Annuities

With a fixed annuity, the insurance company promises to pay you a guaranteed interest rate on your investment. Thus, making it a lot like a CD (Certificate of Deposit)—although in some instances, the interest rates under a fixed annuity may be higher than what the average CD is paying. And while many like CDs because they are backed by the FDIC program, fixed annuities are backed by the State Guaranty Fund (up to $300,000 in North Carolina).

With a variable annuity, the cash value in the annuity policy is invested in equity and bond subaccounts—meaning that the value of your annuity can go up or down depending on market performance, therefore returns are generally not guaranteed.

In my opinion, variable annuities should be approached with caution as a retirement planning strategy—if you can’t afford for your policy to lose value (i.e., it would severely compromise your retirement lifestyle), then it may not be the right tool for you. And unfortunately, variable annuities are the reason why you may have heard “bad things” about annuities. Like all things, not all annuities are bad, nor are all annuities are good. They must be used for the right purpose and with an understanding of how they work. Unfortunately, variable annuities were sold quite aggressively to some seniors during bullish markets and many were devastated with then great recession wiped out a significant portion of their policy value.  In response, some variable annuities now offer “guaranteed living benefit” riders, but you’ll pay extra for the added security. These riders are also a newer creation so it’s too soon to tell how these riders will really play out during a future recession.

Surrender Charges

Most annuities are designed to be longer-term investments. Just like banks offer higher interest rates on longer-term CDs, the same is typically true with annuities. Most annuities will be subject to “surrender charges” during the early years of the contract if you cancel the contract early. Under North Carolina law, annuities are required to give a 10-day “free look” period when you first purchase a policy (or 30-days if it’s replacing an existing life insurance or annuity policy) to change your mind. After that, the policy may be subject to applicable surrender charges are set forth in the policy contract.

Some policies will carve out special exceptions such as allowing you to withdraw up to 10% of the cash value per year without penalty or that surrender charges will be waived if you need skilled nursing home care, so it’s important to read your policy closely.

We Can Help You Develop a Long-Term Care Plan

Having assisted many Wake County clients with long-term care planning, our team at Carolina Family Estate Planning understands that developing a long-term care plan is about not just protecting your own independence and dignity, but also protecting those you love from the physical, emotional, and financial toll that caring for a loved one can take.

We’ve helped many clients take an interdisciplinary approach to their long-term care planning by exploring both legal and financial options. Usually, a well-rounded long-term care plan will involve a combination of legal, health care, and financial tools to meet your goals and maximize your protection. To get started, register an upcoming seminar to learn more or call our office at 919-443-3035.

 

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