5 fixed annuity questions you should be asking

Quick, you have the option to retire with an annuity that has an income rider value of $150,000 or $200,000. Which one would you choose?

Obviously, you choose $200,000. However, now you find out that your withdrawal rate at your current age is five percent on the contract you took and eight percent on the one you left on the table. Even though your contract has a big, attractive number on it, your annual annuity income would have been 20 percent higher — $12k per year versus your $10k — on the "smaller" contract.

Fixed annuities are often aggressively (and erroneously) marketed like investments. This causes advisors to focus on high rollup rates and big bonuses. While these features are certainly important factors in determining the annual payment a client receives, the withdrawal rate is often left out. This can dramatically change the payment if it's moved even a single percentage point. A strong rollup can be a great advantage if you have time to defer before retirement, but with a low withdrawal rate during retirement, that advantage evaporates quickly.

Let's say you are stranded in the desert with limited supplies. If you have a water tank that holds 20 gallons, you shouldn't be thirsty for a long time. But what if the bottleneck is a millimeter wide? Now the water won't help because it's going to take you hours to get one drink out of it. Likewise, a gigantic income value doesn't help if you can only withdraw a tiny percentage of it per year. It pays to check every number that goes into the final calculation, not just the flashy ones.

4. How do flexible premiums affect my contract?

With annuities quickly evolving, it's not unheard of for a client to use a deferred annuity in a manner similar to a qualified retirement plan — making small contributions monthly or annually with the intent of using them for future income. Not all contracts allow this, of course, but among those that do, there are still several factors to take into consideration.

The first that many ask about is the dreaded "rolling surrender." This term describes each new premium starting its own surrender schedule. For instance, if you have a seven-year surrender schedule and deposit additional premiums in year four, you won't be able to access your full value until year 11. The good news is that the rolling surrender is virtually extinct at this point and most contracts become liquid after the surrender period regardless of additional premiums. A few are still kicking around though, so be sure you know exactly what you are dealing with.

More often, you should consider how the terms of the contract helps or harms the client's retirement plan. If the product has a bonus, does it only apply to premiums in the first year? Some allow you to get the bonus for several years, which give the contract value a great boost. Some deferred income annuities (DIAs) allow flexible premiums, as well. The thing to keep in mind is that because income annuity rates change frequently, you won't know the eventual monthly payment with 100 percent accuracy until the final premium is paid.

Any time the client is planning to make flexible deposits into the contract, it's a good idea to look into how that will affect his or her income and retirement in the long run. Small differences between contracts can make a huge difference when born out over ten or fifteen years.

5. Is there a bailout or an ROP?

One of the greatest objections to an annuity contract, especially with the suppressed rates we've been experiencing for the last few years, is that rates will rapidly rise and a client will "miss out" on lots of juicy interest because he or she is locked into a low rate. While it's mathematically unlikely that sitting on cash earning less than one percent is a better option than earning some appreciable interest in an annuity, it remains a big sticking point for a lot of consumers.

See also: The 2015 interest rate outlook: 7 questions answered

What those consumers (and you) may not know is that there are fixed annuity contracts that offer an exit strategy. This is known as a return-of-premium, or ROP, feature. Note that this does not mean there is no surrender schedule. It does, however, mean that when the contract is surrendered, the client is guaranteed to never receive less than what he or she puts into the contract, minus any withdrawals he or she has already made. This means that if the fabled return of rates occurs in the next couple of years, the client can safely exit the contract without incurring a net loss and move the funds unhindered.

In the same vein, some contracts offer a "bailout" cap, usually set fifty to a hundred basis points below the current cap. The bailout feature allows the client to exit the contract and keep any interest earned, if the annual cap is ever renewed below the bailout level. While this does not provide quite the same level of flexibility as an ROP, it can be another great safety net for the liquidity-minded client.

While some of these features and concepts may be elementary to the average advisor, it pays to remember that clients do not know all the ins and outs of a fixed annuity, and are unaware of the potential advantages they offer. Ask these questions about the next annuity product you look at and you may find it's an unexpectedly good fit for them. Good luck out there!