How To Get Over Past Mistakes

Common Annuity Mistakes and How to Avoid Them

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Reaching an annuity agreement with an insurance company or other entity is an important occasion — and often one that brings a great deal of relief with it, whether it's the result of a lawsuit or simple negotiations to work out your retirement plan. However, this doesn't mean it's time to kick back and relax. You'll still have a series of key decisions to make and pitfalls to avoid. Annuities can be complex and dealing with them can be complicated, which is why it's so critical to manage yours properly. Avoiding these common mistakes can help you successfully navigate your annuity's limitations while overseeing your finances in a way that's right for your individual situation.

Purchasing the Wrong Type of Annuity

Retirement annuities are perhaps the most common types, and people purchase these investment products to supplement their Social Security income and pensions. They act similarly to pensions, paying out a set amount of money at regular intervals for a specified period of time — usually until you pass away. This source of lifetime income is appealing to most people who want an added bit of financial security during their golden years, but it's important to select the right type of annuity for your needs.

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Often, people choose between fixed and variable annuities. Like fixed and variable loans, these payouts either disburse fixed amounts that remain the same over time or disburse amounts that can change based on market conditions. You also have the option to pick an immediate annuity, in which you pay an insurance company a lump sum and the company begins making payments back to you almost right away, or a deferred annuity, which sits for a period of time (called the accumulation phase) earning tax-deferred money while you wait to receive payments. Immediate annuities are almost always fixed

"Wrong" in these cases is subjective, and the option that's right for you ultimately depends on the level of risk you're comfortable with and how certain you are that you want to invest money in an annuity. Immediate fixed annuities are lower-risk in that they're not subject to fluctuations based on market volatility. However, the money you invest in them is irrevocable, meaning you can't get it back out in whatever way you want once you've invested it and signed the contract. They're ideal if you care most about guaranteed payouts to help you maintain income throughout your life.

With many variable annuities, you can withdraw money as you need it — though you may face penalties and lose money for doing so, and your investment is liable to lose money based on market performance. If you're looking for an investment with more potential for growth and more flexibility, a variable annuity may be the right choice for you. Likewise, if you're older or already in retirement an immediate annuity may be more appealing than a deferred annuity, which needs some time to grow and is often more appropriate for younger investors.

Not Carefully Considering the Payout Details

Again, the "right" payout amount will depend on your individual situation, but you need to consider a few things before arriving at that number. For example, are you single, or do you have a spouse whom you'd want the annuity to continue supporting if you were to pass away? If you're not married, you might feel more comfortable taking a larger monthly payout. If you're married, on the other hand, it may be in your best interest to take smaller payouts so there's a better chance money is remaining in the annuity to go to your spouse after your death.

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While some elements that you can't control, such as your age and gender, which both help determine your life expectancy, factor into the amount that an annuity pays out each month, you have a choice in others. The payments can vary between investment companies based on the projected investment returns they offer, which may differ by several percentage points depending on where the company is investing the money and the type of annuity payout option you're thinking of choosing

What are payout options? They're the different choices you can make for determining when your payments are disbursed and the length of time you receive them. One of the most popular payout options is called life annuitization; this gives you an income stream that lasts until your passing, even if you end up needing more than your annuity was worth. Joint-life annuitization allows the payments to transfer to your spouse or another beneficiary upon your death. Some people also opt for period-certain annuitization, which is guaranteed to pay out your annuity over a specified period of time, or term — often 10, 15 or 20 years. If you die before the term ends, this type of annuity is guaranteed to continue paying out to a beneficiary for the remainder of the term. Discussing these options with a financial advisor who isn't affiliated with any particular insurance company is an effective way to get unbiased information.

Not Reading the Fine Print

This is true for all contracts, of course, but when you're choosing an annuity it's essential to be aware of its various provisions and limitations. Some of the newer annuities on the market are so confusing that many investors and financial advisors have trouble understanding and explaining them, respectively. Ignoring small details now can kick off a "butterfly effect" that results in serious consequences later on.

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Here's an example. Imagine that you pay a lump sum into a life-income annuity that's guaranteed to disburse fixed monthly payments throughout your lifetime, even if the overall amount paid out eventually exceeds what you initially invested. However, several months after your annuity begins making payments to you, you pass away. You invested quite a bit of money, and it seems natural that the insurance company would continue paying the remainder out to your surviving spouse, who's now counting on that income. Unfortunately, you missed the detail in the contract that you'd need to purchase an installment refund rider in order for your spouse to continue receiving payments. The insurance company is thus allowed to keep the remainder of your investment after your passing because the annuity didn't offer joint-life annuitization.

It sounds dramatic, but it's common for annuities to not automatically transfer to beneficiaries. This highlights exactly why it's critical to be aware of the details included in (or left out of) an annuity contract before you sign it. Depending on the amount of money you're investing and how well-versed you are in financial products like these, it may be worth it to have an experienced lawyer look over the contract. You can explain your situation and your goals in purchasing the annuity, and the lawyer can bring up questions to ask the insurance company and issues that aren't compatible with your goals.