Broker Check

Understanding Annuities Part 3

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Table of Contents

Indexed Annuity Advantages and Disadvantages
Indexed Annuity Checklist
Important Information

Indexed Annuity
Advantages and Disadvantages

An indexed annuity can be a great way to save for retirement on a tax-deferred basis, in effect creating your own personal "pension" plan. As with any investment, however, there are also potential disadvantages that should be evaluated before purchasing an indexed annuity.


  • An indexed annuity provides the opportunity to benefit from a rising stock market with an interest rate linked to a market index, while also offering a minimum guaranteed interest rate.
  • Indexed annuity earnings are tax deferred so long as they remain in the annuity. When compared to an investment whose earnings are taxed each year, tax deferral offers the potential for accumulating significantly higher amounts of money over time.
  • An annuity can be used to provide a steady source of retirement income that you cannot outlive.
  • Unlike an IRA or employer-sponsored retirement plan, there are no annual contribution limits to an annuity…you can contribute as much as you want.
  • Subject to the terms of the contract, there is no required date by which you must begin receiving annuity income payments, providing you with the flexibility to defer payments until you need the income.
  • If you die while your annuity still has value, the annuity death benefit passes directly to your beneficiary without probate.
  • In most states, an annuity is free from the claims of a creditor.


  • Premiums for a non-qualified annuity are not tax deductible, meaning that they are made with after-tax dollars.
  • While you can surrender or make withdrawals from an annuity before you begin receiving income payments, the surrender or withdrawal may be subject to a charge if made within a stated number of years after the annuity is initially purchased. Withdrawals will reduce the value of the death benefit and any optional benefits.
  • There is a risk of losing money if the issuing company does not guarantee 100% of the principle and no index-linked interest is credited, or if the indexed annuity is surrendered while a surrender charge is in effect.
  • If made prior to age 59-1/2, a surrender or withdrawal will be subject to a 10% federal penalty tax unless one of the exceptions to this tax is met.
  • When received, investment gains are subject to ordinary income tax rates and not the lower capital gains tax rate.
  • Once annuity income payments begin, the payment amount cannot be changed and withdrawals above the payment amount generally are not available.
Indexed Annuity Checklist
Once you decide that an indexed annuity is right for you, there are a number of factors you should consider in evaluating the specific annuity you will purchase. These include:

Fees and Expenses

The indexed annuity fees and expenses an insurance company charges can include:
  • Premium charges deducted when premiums are paid;
  • A margin, spread or administrative fee, which is subtracted from any gain in the index before interest is credited to the annuity;
  • An annual maintenance fee (e.g., $30); and/or
  • Surrender charges assessed if the annuity is surrendered or withdrawals are made.
Carefully evaluate fees and expenses, since they will impact the amount of money ultimately available in the annuity.

Insurance Company Ratings

Since an indexed annuity is an insurance contract, you need to be able to count on the financial strength and claims-paying ability of the insurance company from which you purchase an annuity. Ask for company rating information from respected sources, such as A.M. Best, Moody's or Standard & Poor's, before purchasing an annuity.

Annuity Features

Make sure you understand the terms and limitations of an indexed annuity contract before you purchase it, including:
  • the indexing method used and the term of the contract;
  • the minimum guaranteed interest rate;
  • the participation rate and for how long it is guaranteed;
  • policy features such as a cap, whether averaging is used and if interest is compounded during a term;
  • any vesting provisions and withdrawal and surrender options;
  • how the death benefit is determined and the payout options available;
  • the income payout options available.