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Annuities 101

Steven Aul

I cannot count the times that I have sat down with a couple and asked what they would like to have in their retirement portfolio, and they tell me they want to have guaranteed income they cannot outlive, maintain their principal with little or no risk, and be able to participate in the market when it increases.

They get excited when I reveal that there are tools that meet these requests, but when I mention the word “annuity,” they grow horns. I believe this negative reaction comes from people being sold annuities they did not understand and were likely not appropriate for them. They may have had excessive surrender charges and surrender periods. That’s why I want to go over some “Annuity 101” on the basics of annuities.

To begin, not all annuities are alike! Let’s discuss some different terms and options:

  • Variable and fixed annuities, which include indexed or hybrid
  • Single or multiple premiums
  • Accumulation phase: immediate and deferred
  • Distribution phase: free withdrawals/annuitize
  • Riders: income/roll-ups/death benefits

It’s very important to find an advisor who has knowledge of how each of these options works and the ability to recommend both variable and fixed annuities!

Variable Annuities

With variable annuities, money is held with subaccounts, which have exposure to the market. They rise and fall in value as the underlying asset rises and falls. They are investment products that are sold by a prospectus. The biggest thing about variable annuities is that the risk is transferred to the contract owner.

Fixed Annuities

Most fixed annuities have set interest during the accumulation phase of the contract and come with no market risk.

Indexed or Hybrid Annuities

With indexed or hybrid annuities, money is not in the market, which means that you cannot lose money due to market volatility. The market is a yardstick for how interest will be paid. For the acceptance of a floor of zero, there are caps or spreads on the amount of gains credited to the contract.


A roll-up is when an insurance company offers a guaranteed return on your investment, for income purposes only, in the years prior to taking withdrawals. I often meet with clients who come to my office stating they have an annuity contract that guarantees them a return of 6, 7 or 8%. Typically, what they actually have is a guaranteed rate of return for income purposes that is then multiplied by the withdrawal rate to get what their income payment will be. Let me reiterate, in most of these contracts, the guarantee is only for the purpose of figuring what the income payout amount will be, not the actual contract value. Sometimes, this roll-up rate will be called the “income base,” GMWB, or “Guaranteed Minimum Income Amount.” To clarify the terms, make sure to read the prospectus if it is a variable annuity, or the statement of understanding for a fixed indexed annuity.

For our purposes, let’s call it an “income base.” Some income bases grow at varying rates: 5 %, 6%, 8% or 10%. Some are simple, while others are compounded. Some have high water marks, and some have “step-up” provisions, where gains are permanently locked into the contract benefit base.

Withdrawal Rates

The withdrawal rate varies by contract depending on the age of the client. Do you want single or joint life payout? How about steady or increasing payout? The income base is then multiplied by the withdrawal rate to get the Guaranteed Lifetime Income Amount.

I know this sounds difficult, but it doesn’t have to be.

What NOT to do when evaluating annuities:

When comparing an annuity to other investment products, there are three common mistakes:

  1. Unfair Comparisons
  2. Focusing on Returns
  3. Failing to Annuitize

Unfair Comparisons

  • All the costs within an annuity are not pure overhead; costs are charges for the transfer of risk from the buyer to the insurance company.
  • When analyzing risk management strategies, we need to look at what risk we transfer for the cost (e.g., income stream, asset protection).
  • You cannot compare a non-qualified mutual fund that has no insurance benefit with an annuity that does, and then say, “See, it is more expensive.”

Focusing on Returns

  • When we analyze your portfolio and determine that the reason to buy an annuity is that you “want the absolute assurance of having that income in your checking account every month,” then annuities, in this case, are not about rates of return. They are about the absolute assurance of income that you cannot outlive.
  • Look at annuities for spending and consumption.
  • Simply, think of annuities as income streams, not investments.

Failing to Annuitize

  • The biggest mistake is failing to start the income on the annuity.
  • Starting the income from a portion of a portfolio can significantly reduce the failure rate of that portfolio to produce income over a required period of years, which may be a lifetime. But many never start!

The secular bear market that we just went through has shown us that it is tough to take money from a portfolio and have that portfolio survive for a long time. Consult with a trusted financial advisor and make sure the annuity you are considering is the right tool for its intended purpose.

About the Author:

Steven Aul, CHFC®, RICP®, is the president and CEO of Aul Financial Group. He serves his community by helping with pre- and current retirement planning. As an independent advisor, Steve prides himself on his ability to locate tools and offer services that drive you toward your financial objectives. Educating his clients about the different options available to them is important to Steve, and his goal is to simplify complex issues of retirement for clients planning for their futures.

To contact him, call (866) 747-2822 or email Visit to learn more about Steven’s practice.


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