How do hybrid annuities work?

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Dear Senior Living Adviser,
I’m hearing more and more about a hybrid annuity that can provide guaranteed returns, ranging anywhere from 4 percent to 8 percent fixed annual yield. Is there a catch? How do annuities work?

— Steve Skeptic

Dear Steve,
There’s always a catch. There are different types of hybrid annuities. In general, hybrid annuities combine the benefits associated with a deferred annuity with those of an immediate annuity.

Deferred annuities have an accrual value where the principal balance is growing based on how the annuity is invested and other contract provisions. Once the annuity payments start, the contract is no longer in deferral and behaves from that point on as an immediate annuity in line with the contract provisions.

The options (read: bells and whistles) you buy with your annuity contract control how it behaves over time. You can buy options to meet many different financial needs, including:

  • Account growth guarantees during the deferral period.
  • Income growth during the income period.
  • Long-term care payouts.
  • Survivor benefits.

It’s important to recognize that account benefit growth and income benefit growth are not the same thing.

One type of hybrid annuity is a fixed indexed annuity with a guaranteed lifetime income rider. The account value can go up, and it won’t lose money.

Another type of hybrid annuity is a variable annuity with a lifetime income rider. Variable annuities aren’t tied to the performance of an index; rather, they’re tied to the performance of the investments held in the variable annuity.

After a market sell-off like we had in 2008, where the S&P 500 on a total return basis fell by 37 percent, investors look for a way to be involved in the market but not be subject to the downside risk. Equity-indexed annuities can do this, but at a fairly high cost to the contract holder.

In the current low interest-rate environment, fixed annuities have very low yields. An investor reaching for yield can see these hybrid annuities as an alternative to a fixed annuity with a low yield.

Retirees already have an inflation-indexed annuity designed to last a lifetime, with benefits paid to a surviving spouse — their Social Security benefits. Since hybrid annuities have long surrender periods, with high surrender fees to unwind a contract, I’d counsel seniors considering these investments to get completely comfortable with the contract design and provisions before signing the contract. When in doubt, hire an independent fee-only financial planner to review the contract prior to signing it.

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