5 Annuity Misconceptions That Could Hurt You
Author of the beloved classics The Adventures of Tom Sawyer and Adventures of Huckleberry Finn, Mark Twain is also attributed with this quote: “It’s not what you don’t know that kills you, it’s what you know for sure that ain’t true.” In many cases, it’s the things you think you know that can hurt you. At least when you’re in the dark, you know enough to turn on the light.
The following 5 misconceptions about annuities might be preventing you from getting the very thing you need the most. According to more than half of the adults polled for a 2016 survey done by TIAA, the main goal of their retirement savings is to provide an income during retirement. Yet when asked if they were considering an annuity – the only investment that can actually provide an income – only 23 percent answered yes. What’s the problem here? Take a look at the following misconceptions to find out if you’re guilty of knowing something “for sure” that simply ain’t true.
MISCONCEPTION #1: If I put my money in an annuity, I’ll never be able to touch my money again.
This misunderstanding probably comes from the types of annuities that were sold back when Mark Twain was still alive. Annuities have had a long and illustrious history. Many famous people such as Abe Lincoln, Ludwig von Beethoven, and Babe Ruth have owned annuities. It used to be that all annuity contracts were annuitized. This is not true today.
To annuitize a sum of money basically means to make a trade: you give the insurance company a lump sum of cash, and they parcel out that cash for you in the form of income payments. For example, you can put $350,000, into an annuity in exchange for a guaranteed paycheck of $1,550 a month for 20 years. If you need to access your money to buy a new condo, you can’t. The most that you can take out is the $1,550 a month.
Some annuities still work this way today. An immediate annuity, for example, will take your lump sum investment and turn it into an immediate income payment that will continue for a set period of time, regardless of what the stock market does. This can be a simple, straightforward way to guarantee income.
In order to stay competitive, however, insurance companies have come out with several different options that now give you the ability to do two things: guarantee your income and have greater access to your money. In exchange for a small fee or a slightly lower income amount, you can guarantee an income – for 20 years or for life – without having to annuitize the money.
MISCONCEPTION #2: If I die tomorrow, the insurance company will get all my money.
This is another example of the traditional way annuities are set up. They functioned very much like traditional pension payments or Social Security, in that the income is connected to one person’s life. Once that life is over, the payments stop. This isn’t necessarily a bad thing, especially if you believe yourself to be in good health.
Today, you can still choose to buy this type of an annuity, which in many ways is a type of insurance against the risk of living too long. However, if you have other people who you care about and want to take care of, you can make arrangements for them. Even immediate annuities give you the option for joint-life income, which can guarantee income for your spouse. Other types of riders can guarantee that any money left over in your annuity account will go to your beneficiaries and not the insurance company.
MISCONCEPTION #3: Annuities are expensive investments.
You might say that annuities are like ice cream cones: they come in different flavors. There is one “flavor” of annuity that may certainly qualify as expensive. Variable annuities have high fees, because not only do they guarantee income, they also invest funds in the stock market. This means you have to pay both the insurance fees and mutual fund fees. This is what might make the variable annuity one of the most expensive investments you can own.
Fees reduce any gains earned by your money, and they can have a significant impact on the overall return of your investment over time. You don’t have to pay high fees in order to guarantee yourself an income. Fixed indexed annuities offer income riders that can guarantee you an income for life for as little as a 1 percent. Other types of deferred annuities can also grow your money for later so that you can turn on the income when you choose. Conversely, if you don’t need an income from your money, then you shouldn’t be paying the income rider fee.
It sometimes happens that investors end up paying fees for features or benefits that they don’t really need. To have your annuity tested for its fee structure, GO HERE. The only way to ensure that you’re getting the best annuity for the best price is to shop around and compare.
MISCONCEPTION #4: I can’t access my money for emergencies if it’s in an annuity.
An investment’s ability to give you access to your cash is known as its liquidity. We only partly addressed the issue of liquidity with misconception number one. It’s true that annuities are, generally speaking, designed to be long-term investments. Insurance companies need to have a longer time horizon in order to invest in the kinds of things that provide more stable returns. To that end, they assess surrender charges if you try to withdraw the money too early.
However, life insurance companies also know that unexpected things often come up. Even if you have an emergency savings account, it’s nice to know that your annuity also comes with a safety net. Most indexed and fixed annuities allow access of up to 10 percent of your funds without penalty. If you have a $500,000 annuity, for example, you would be able to access $50,000 a year penalty-free, with no surrender charges. Some companies also offer greater access to funds in the event of a long-term care situation.
Other annuities, such as the variable kind, might restrict or lower your income payments if you make too many withdrawals. Because they are annuitized, immediate annuities don’t offer the 10 percent withdrawal amount at all. Before buying an annuity, be sure you ask the right questions to make sure you have access to the cash that you need.
MISCONCEPTION #5: Annuities are freaking complicated.
Yeah, it certainly sounds that way, doesn’t it? Reading about surrender charges, penalties, fees, and income riders can send a person running for the hills. The good news is that the annuities designed to produce income are usually pretty straightforward. Even if you add an income rider, if you ask the right questions, it’s not that hard to understand the basics of how they work.
Immediate annuities are designed to give you an income now; deferred annuities (sometimes called longevity annuities) are designed to grow your money first for a period of 10 to 20 years before paying out the income. Deferring your income payment allows you to lock in a future monthly payment for a smaller investment amount because the money has time to grow. While the inner workings of the growth mechanism might seem complicated, keep in mind that annuities, unlike market investments, come with guarantees. You don’t have to be watching the S&P 500 in order to find out whether or not your income check will arrive. All of that is taken care of for you once you get your annuity in place.
To use another analogy, annuities are like watches – you don’t have to know how all the inner gears work in order to be able to tell the time. Still, you never want to get into an annuity that you don’t understand. If you have questions about an annuity that you own or are thinking to buy, reach out to one of our experts. We’ll be happy to answer your questions, no strings attached.