Action Steps: How to Thoughtfully Consider an Annuity

If you believe an annuity might have a place in your retirement plan, it’s time to move from learning to doing. This is not a product to be purchased quickly or lightly. A slow, methodical, and skeptical approach is your best strategy. Here are five steps to guide your evaluation process.

Step 1: Map Your Cash Flow

Before you can even think about a solution, you must deeply understand the problem. Take the time to create a detailed retirement budget. List all your sources of guaranteed income (Social Security, pensions). Then, list all of your expenses, and be honest with yourself. Divide them into two columns: essential (needs) and discretionary (wants). This simple exercise will give you a clear picture of your financial situation.

Step 2: Calculate Your Income Gap

Subtract your total essential expenses from your total guaranteed income. If the result is positive, you are in a strong position. If it’s negative, that number is your income gap. This is the amount of monthly income you need to create to ensure your basic lifestyle is secure. Knowing this exact number helps you avoid over-committing your savings to an annuity.

Step 3: Research and Compare

Do not buy the first annuity presented to you. This is a competitive market. Get quotes from several different highly-rated insurance companies for the same type of product. Compare the payout amounts, the fees, the surrender charge schedules, and the company’s financial strength rating. Use unbiased government resources like the U.S. Securities and Exchange Commission’s educational site, Investor.gov, to learn more about the products and the questions you should ask.

Step 4: Ask the Hard Questions

When speaking with a financial professional or insurance agent, become an investigator. Ask them to provide a written, line-by-line breakdown of every single fee and charge. Ask for a clear explanation of the surrender period and the exact penalty for each year. Ask them to show you the insurance company’s credit rating from at least two different rating agencies. If you don’t get clear, simple answers, that’s a major red flag.

Step 5: Read the Contract and Consult a Professional

The annuity contract and prospectus are the final source of truth. They will be long and dense, but you must review them. Pay special attention to the sections on fees, surrender charges, and how payout options work. Because these are complex legal documents, it is highly advisable to have a trusted, qualified professional review the contract with you before you sign. Consider working with a fee-only financial planner who is obligated to act in your best interest. You can find resources for finding financial help on the Consumer Financial Protection Bureau website.