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10 Questions to Ask Before Buying a 403(b) Fixed Annuity
by G. Wade Caldwell a partner with the law firm of Martin, Drought, and Torres, Inc.

Fixed 403(b) annuities can be a good investment for the retirement needs of teachers and other not-for-profit workers. However, some annuity marketing schemes exist which boggle the mind, and make the task of wise annuity selection a difficult one. So how does a wise investor weed out the good annuity products from the bad?
 
  In purchasing a 403(b), there are three major components to consider:
What does the contract say?
Historical performance
Safety ratings
 
  The following questions may not expose every problem that may exist, but it is a good way to make a rough cut.
 
1. Do I Need an Annuity?
An annuity is the reverse of life insurance. Life insurance protects you from dying too young, while an annuity protects you from living too long after retirement. Teacher retirement is an annuity program. Social Security is an annuity program. Before buying another annuity, ask yourself, do you need additional protection from living too long? Most people want to keep a cash reserve that is not tied up in annuities to cover medical emergencies or other unexpected expenditures. Tying up a substantial portion of your liquid assets in an illiquid investment such as an annuity, can restrict your financial flexibility.
 
2. What is in the Contract?
Are the payout options guaranteed?
Is the loan provision guaranteed?
Is your ability to select payout options always guaranteed?
 
  A good annuity has solid guarantees in these areas. Find out what the guaranteed rate of interest is on the accumulation and payout phases of the annuity.
 
A competitive interest rate and guaranteed flexible payout options are signs of a good annuity. Avoid those annuities which have experienced historically low rates or try to offer guarantees with limitations.
 
3. Does the Salesperson Have a Product Brochure and a Specimen Contract Available?
Beware of the salesperson who wants to explain his product to you verbally, without leaving any insurance company materials to back up the promises. Reputable companies have a brochure describing the product, a specimen contract for you to examine before you sign the application, and a disclosure form summarizing some of the product features. In Texas, at the point of sale, all K-12 employees have to be given a disclosure form approved by the Teacher Retirement System describing key features of the annuity. A salesperson who does not have these materials does not know his product, is ashamed to put it in writing, or wants to avoid a comparison to your existing 403(b).
 
In Texas, each agent is required to carry a copy of their insurance license. Some agents work for agencies, which also have licenses. It wouldnÕt hurt to also require the agent to show you a copy of his agency license, especially if the name of the agency has "educator", "education" or "teacher" in it. Reputable agents and agencies will have the proper credentials.
 
4. Is the Annuity Being Used to do Things an Annuity is Not Intended For?
Beware of the salesperson who is marketing an annuity as part of a loan program to reduce your debt, to save for things other than retirement, or especially to pay a life insurance death benefit. While some annuities do have these features, or can be used this way, a sure sign of a shady operator is to emphasize things other than the main purpose of an annuity to get you to switch. A good 403(b) annuity is to save for retirement using pre-tax accumulations and provide protection against living too long through the option of a lifetime payout
 
5. Is Your Annuity Being Sold by an Established, Well-Rated Company?
The 403(b) annuity market has attracted a lot of smaller and mid-size insurance companies, jumping into the business as a quick way to build assets. Often, these companies have lower safety ratings, and lack the experience, or historical performance, to design and sell products which will perform well in the long run.
 
Although there are state guarantee funds in case insurance companies fail, you will want to look at the safety ratings of the company you are buying from. The main rating services are Moody's , Standard and Poors, Fitch, Weiss, and A. M. Best. Each one publishes a summary of what their ratings mean. A good rule of thumb is for your company to be highly rated from these rating services over the last ten years.
 
Equally important is to find out how long the insurance company has been in the 403(b) business. Unless the company has been in the 403(b) market for more than 10 years, it is one to be avoided.
 
6. What Are the Surrender Penalties?
Surrender charges (penalties) are the deductions that are taken from an annuity when it is surrendered. These penalties are often called "withdrawal charges."
 
A well-designed annuity does not charge surrender penalties after you retire and annuitize the contract. Also, surrender penalties which last for a large number of years, charging high percentages, usually mean a high commissioned product. The Texas Retirement System has set maximum surrender penalties which must decline annually on all annuities that can be sold in the K-12 market. Also, find out if there is any way the surrender penalties could be "reset" if you make any adjustments to your contract.
 
7. Does the Annuity Have a Bonus?
Bonus annuities usually come in one of three forms. First is bonus interest on your actual contribution, i.e., $100 contribution + bonus of 5% = $105. You then receive interest on the $105.
 
The second type of bonus is a higher rate of interest, usually for one year, to entice investors. Bonus annuities are especially used to try to get investors to rollover from another company. A higher rate of interest paid in the first year of a contract will eventually be recouped, usually through lower renewal interest rates on the annuity. Since an annuity is supposed to be a long-term investment, do not be fooled with a first year interest rate gimmick.
 
A third form of bonus is one which is only paid when the contract is annuitized for life. If you are told about a "bonus", find out whether it is a first year bonus, or whether you have to stay with the company and annuitize for life to get the bonus. If it is a lifetime annuitization bonus, find out if there are any other conditions to obtain it. Annuitization bonuses which only apply to lifetime payout options are of little value.
 
Keep in mind that all bonuses are really just a gimmick to increase sales. A bonus has to be made up somewhere during the life of the contract. This often leads to product designs which will make up the bonus through lower interest rates in future years.
 
8. How Will Interest be Credited to the Annuity?
Most companies credit interest to annuities by using "old money/new money" interest crediting. This means a higher rate of interest is credited for the first twelve months after it is deposited into the annuity. After twelve months, the rate for this "old" deposit changes, usually (but not always) being lowered.
 
While old money/new money interest crediting is very common, ask about the difference between the old money and new money interest rates. A large gap between the new money rate and old money rate is usually indicative of a design gimmick to try to disguise how much interest is being credited in the contract.
 
9. Does the Salesperson Have a Marketing Arrangement with Someone?
Although now illegal in Texas, some marketing groups still manage to get exclusive access to district employees through friendly administrators, employee benefit administrators, and by other means. Some marketing groups and companies have paid fees to local, state and national teacher organizations for endorsements or other types of access to their members.
 
In Texas, it is illegal for districts to provide exclusive access to employees. Also, any endorsement fees have to be made up somewhere, usually at your expense in the lack of guarantee or even the performance of your annuity.
 
10. Is the Annuity a Variable or Equity Indexed Annuity?
Other types of annuities exist other than fixed annuities, and each has its own set of problem areas. If an annuity is sold with a promise of stock market type returns, it is probably an equity indexed or variable annuity. The pitfalls with these products are many and too numerous to list in this article.
 
The firm Martin, Drought, and Torres, Inc. has prosecuted numerous class-action lawsuits against insurance companies and agents on behalf of teachers across the United States.
 

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