Annuities – The Basics and 4 things to keep in mind

Annuities have become a common product sold to customers by Brokers and/or Investment Advisors.  In a lot of cases, a Broker and/or Investment Advisor may generally explain a few “broad strokes” of what an annuity will do for you, but will provide you with a copy of the annuity contract and a lot of reading material and you will be expected to review these materials and to process what they say all on your own.  Annuity contracts are difficult to read and even more difficult to understand.  This article will provide basic information about annuities in general and about the three different types of annuities.

At their heart, annuities are a contract between you and an insurance company.  The annuity contracts are long and very difficult to read.  In an annuity contract, an insurance company will make promises to you in return for your payment of premiums as specified in the contract.  The promises that are made to you in the annuity contract will vary depending upon the type of annuity that you are purchasing. 

Some annuity contracts provide a way to save for retirement. Others can turn your savings into a stream of retirement income. If you use an annuity as a savings vehicle and the insurance company delays your pay-out to the future, you have a deferred annuity. If you use the annuity to create a source of retirement income and your payments start right away, you have an immediate annuity.

Annuities come in three basic varieties: fixed, variable and indexed.

With a fixed annuity, the insurance company guarantees both the rate of return (the interest rate) and the payout to the investor. Although the word “fixed” might suggest otherwise, the interest rate on a fixed annuity can change over time. The contract will explain whether, how and when this can happen. Often the interest rate is fixed for a number of years and then changes periodically based on current rates. Payouts can be for an entire lifetime, or you can choose another time period.  

A variable annuity is very different from a fixed annuity.  The rate of return for a variable annuity changes with the stock, bond and money market funds that you choose as investment options and unlike a fixed annuity, a variable annuity does not provide any guarantee that you will earn a return on your investment.  In other words, you could actually lose money. 

Indexed annuities—also known as “equity-indexed annuities” or “fixed-indexed annuities” are complex financial instruments that have characteristics of both fixed and variable annuities. Indexed annuities offer a minimum guaranteed interest rate combined with an interest rate linked to a market index. There are several indexing methods firms use to calculate gains. The method used for your annuity matters because it will impact the calculation of the amount of interest to be credited to the contract based on the change in the index. Because of the guaranteed interest rate, indexed annuities give you more risk (but more potential return) than a fixed annuity, but less risk (and less potential return) than a variable annuity.

Regardless of the type of annuity that you are being sold, there are a few things to keep in mind:

  1. Fully understand all of its terms, fees and expenses, and carefully read the prospectus.
  2. Ask specific questions like how long your money will be tied up, whether the annuity has sales or surrender charges, and if the investment poses liquidity risks, has early withdrawal penalties or potential tax consequences.
  3. Find out whether the policy has a “free look” period that allows you to cancel an annuity purchase within a specific period if you have second thoughts.
  4. Ask how your broker is being compensated. In addition to annual fees and other charges, the sales person who sells you a variable annuity is likely collecting a commission for the sale. Variable annuities have many features that can drive up commission charges to customers.

When you are being sold an annuity, your Broker and/or Investment Advisor has a duty to explain the you the material terms of the annuity.  If you purchased an annuity without being explained the terms of the annuity and you have sustained damages, you may be able to recover those damages.

Seth Hill is a Shareholder at Halling and Cayo, a full service law firm in Milwaukee, WI and part of its Securities Litigation team. 

Attorney Hill’s practice focuses on investor’s rights and securities litigation within the FINRA arbitration forum.

Contact him at 414-271-3400 or via e-mail at to see if he can help recover funds.