[IMGCAP(1)]For years, annuities have been considered to be a solution for outliving your income and available assets.

Whether in the form of pension income, with tax-deductible contributions, tax-deferred growth and taxable income, or from non-qualified assets using after-tax monies with the resultant future income partially a return of principal and partially taxable, the goal has been the same. In essence, to create a stream of income one cannot outlive. Also, depending on the payment structure, there might be residual benefits to the heirs and/or beneficiaries.

Over the past two decades annuities have evolved into complex financial instruments that can now help to achieve a variety of goals. Creating a stream of income you cannot outlive, whether taxable or not, is now just one of them. Types of annuities now range from variable, equity indexed, fixed, and immediate, with a host of riders and features such as guaranteed income, enhanced death benefits and home health care benefits.

However, as beneficial and multi-faceted as these annuities can be, there is no “Swiss army knife” or “one size fits all” approach to utilizing them. It is imperative that the planning goals first be prioritized and then work backwards to find the annuity that will be best suited to achieving the primary goal. Categorically, annuities can be broken down into three distinct areas: accumulation, income and death benefit.

Generically, there are two types of annuities that are utilized for the primary goal of accumulation: variable and equity indexed. A fixed annuity crediting a guaranteed interest rate could also be used; however, in this very low interest rate environment they may not be a desirable option. Variable annuities use mutual fund-like sub-accounts, or portfolios designed from these sub-accounts, as the basis for crediting interest. These sub-accounts can be as simple as an S&P index or bond-based strategies, to complex options based on commodities, market neutral and “alternative” strategies. There is true market exposure as the interest generated by the performance of whatever specific blend of sub-accounts is selected is the basis for crediting the gain or loss to the value of the variable annuity. This can also be the most expensive type of annuity from an internal expense standpoint.

Equity-indexed annuities have been available since the mid-1990s. The interest credited to these annuities are based on a variety of indices, such as the S&P 500, the EAFE (Europe), and the Hang Seng (Asia), for time periods of one year or longer. There are caps and/or participation rates associated with the crediting of gains in the selected indices so that there will be a limit on the upside or gain. However, in exchange for giving up full market participation in the event of a negative year(s) in the strategies selected, the account will not experience a loss. Thus, there is a down-side hedge. Overall, equity-indexed annuities will even out the highs and the lows of the equity markets.

When the primary goal is income, there are two options to consider: immediate or deferred. For immediate income the single premium immediate annuity seems like the logical choice. However, you also might be able to utilize an annuity with a guarantee minimum withdrawal benefit (GMWB) rider, or “income” rider, to achieve the same if not better effect. The GMWB is a relatively new feature and is a powerful addition to an annuity for income purposes. It is also one of the most misunderstood. Simplistically, the GMWB creates a “safety net” so that if the accumulation value of an annuity does not perform over time for whatever reason, a stream of income can be created based on the GMWB value, which in most cases will be a higher value that cannot be outlived. This is done via a specific and known annual interest rate or bonus credit stated in the annuity contract in regard to the GMWB when purchased. This income can be paid out on a single or joint life basis.

The catch is this GMWB amount cannot be taken out all out at once. It must be distributed on a specific age-based percentage each year, which is set by each annuity carrier. The interest rates for a GMWB are varied and range from a simple or compounded annual roll-up of the interest, to a flat amount per year, plus a possible additional amount based on the performance of a selected investment strategy. In my opinion, when the goal is income and an equity-indexed annuity is selected with a GMWB to achieve this goal, the accumulation value is sacrificed as it will almost never outperform the GMWB over time. There is typically a cost associated with this benefit.

The third goal is the maximization of death benefit, which can be accomplished via a Guaranteed Minimum Death Benefit (GMDB) rider. In essence, a GMDB will increase the death benefit beyond the annuity’s base value. Furthermore, it is one of the only ways possible to obtain a death benefit in any annuity or insurance product above the premiums and/or accumulated values without having to go through any type of medical underwriting. For those with health issues, impairment, and who might be uninsurable, this may the only option or at the very least the only affordable option.

This GMDB amount can increase based on eligible bonuses and/or a specific annual interest rate. The death benefit of the annuity to which the GMDB is attached will be the greater of the accumulation value or the GMDB value. Frequently, the higher value will be the GMDB value. It can be increased by an annual pre-determined interest rate and additional premium and/or premium bonuses. It can be decreased by withdrawals and surrenders from the accumulation value. There is typically a cost associated with this benefit.

For those that are told that specific annuity can do “everything” well, this may be true to a degree. The real question is how effectively can it do “everything”? The end result is most likely a watered-down product that is far from superb in achieving any specific goal. That is why it is paramount that the primary goal be defined and understood. Only then can an annuity truly be obtained that can reach that goal in the most efficient manner possible. Benefits and riders can be added to help with other areas but these will be secondary. Don’t be fooled—the “Swiss army knife” approach is just not effective and will result in a mediocre solution at best.

Jon Floyd, a principal of LifeVest Advisors and a vice president of ECI, located in Scottsdale, Ariz., began his career in the retirement and estate planning fields in 1992 and has extensive experience in the financial world. During his career, he has worked in both the Wall Street and Los Angeles offices of Oppenheimer & Co., a national investment firm, and managed the Arizona office of MB Trading Futures. He also holds Series 3, Series 30 and Series 34 licenses. He focuses on helping people meet their retirement goals and protect their assets, and specializes in 401(k) and IRA rollovers.