The Advantages And Disadvantages Of Owning An Annuity
A retirement plan has many different working parts. There’s your Social Security benefit, the money in your 401(k) or IRA, and the taxes you owe on that money. You might also have other investments that can gain or lose money in the stock market.
At some point, every investor has to decide how they will use all of these different components to put together an income plan. Annuities are specifically designed to pay investors a regular income once they no longer have a paycheck to rely on, but that doesn’t mean they’re right for your situation. We’ve put together a simple list of pros and cons to help you get started.
#1: Payment Guarantees
While no investment is without risk, annuities can protect you against what retirees fear most: outliving your money. Annuities that have guaranteed living benefits or income riders can give you the guarantee of steady payments that continue for the rest of your life, whether you live to be 85 or 105. There are also annuities that guarantee you won’t lose any of your money due to stock market fluctuations. If you have a certain amount of money that you know you need to rely on for income during retirement, these guarantees can give you peace of mind.
#2: Flexibility of Timeline
If your retirement is five or more years away, deferred annuities can give your income money a place to grow where it will be more secure than market-based investments. If retirement is tomorrow, annuities can also start giving you a regular income right away. Investors have a choice between immediate and deferred annuities. To find out which one might be right for you, GO HERE.
#3: Options for Earned Interest
Some types of annuities are able to offer you income guarantees in addition to an element of growth. You can choose a variable annuity which participates directly in the stock market by investing in mutual fund sub-accounts, or you can choose a fixed annuity with a declared interest rate set for a period of time. A third kind of annuity, known as an indexed annuity, offers market gains that are linked to an index. The amount of your income could be directly affected by the performance of these growth accounts, so be sure to understand your options before committing your money.
#4: Income for More than One Individual
While an IRA may an effective way to help prepare for retirement, it only provides income for one individual, as the name Individual Retirement Account implies. For people who are married, this may not be the best solution. By rolling your IRA into an annuity, investors have the option to build an income suited for two. An index annuity with a lifetime income, for example, offers joint coverage for both you and your spouse. In this way, you can both receive a guaranteed lifetime income from the same pool of money.
#5: Money for Your Loved Ones
It used to be that all annuities were tied to the life of a single individual much like Social Security or traditional pensions. Today, you can find annuities that have death benefit riders and beneficiary options for your loved ones. Should you pass away before the money in your account runs out, the funds can be set to revert back to your loved ones instead of going to the insurance company.
#6: Tax Advantages
Regardless of whether you fund your annuity with an IRA using qualified money, or through payments using after-tax funds, all annuities grow tax-deferred. This means you don’t have to pay income taxes on the growth of your money until you want to spend this money. This can provide some welcome tax benefits for the retiree, especially given the income thresholds that could mean higher taxes on your Social Security.
#1 The Potential for Higher Fees
Typically speaking, all annuities charge a small fee for the addition of the income rider. It is possible to secure an income without the addition of the income rider. It’s also possible to find annuities that are very low cost in terms of fees. If you want to invest in mutual fund sub-accounts, using an annuity is one of the most expensive ways to do so. Variable annuities charge something called a Mortality and Risk fee, or M&E fee, which protects the insurance company from market risk while allowing the investor to participate in market gains.
#2 The Surrender Charge
There are many reasons why you might want to change your mind during retirement. If you discover that you’re paying too much in fees, you might want to switch your annuity to one with lower fees. Because annuities are long-term investments, insurance companies assess a surrender charge. This fee is usually on a sliding scale so that the longer you hold the annuity, the less you have to pay in order to get out of your contract, and eventually, the fee disappears altogether. Typically speaking, surrender fees last anywhere from 5 to 10 years with a sliding scale of 1 to 10 percent of the account value.
#3 Lack of Access to Your Money
To annuitize is to convert a sum of money into a series of periodic income payments. This can be the cheapest way to get an income because, typically speaking, you don’t have to pay a fee for an income rider. Once you begin receiving your income payments, however, you may be in an irrevocable contract. When your money is annuitized, you typically no longer have access to your cash as a lump sum. Investors should consider their liquidity needs before getting into an annuity.
#4 Complicated Features
Some annuities allow you to receive regular income payments without annuitizing your money. These annuities typically use something called an income rider, also called guaranteed living benefits. The addition of this feature still allows you to have access to your money and typically speaking, you can change your mind at some future point. When you choose this option, income riders typically create a secondary account that comes with its own set of terms and conditions. Be sure to ask questions about the income rider and its guarantees to make sure it’s the right option for you.
#5 Contradictory Options
In addition to complicated features, not all annuities offer the same benefit options. We talked earlier about the death benefit rider and beneficiary options of some annuities. Be aware that unlike an IRA or 401(k), not all annuities give you the option to list a beneficiary. Some annuities are set to pay out for a single life only, in which case your loved ones may not get a death benefit once you pass away. If protecting your spouse or loved one is important to you, be sure to read your annuity contract closely so you know what will happen to any money left in the contract once you die.
If you need help navigating the pros and cons of an annuity you are considering, reach out to one of our advisors. We would be happy to have the annuity tested against the other kinds of annuities out there today in order to help you determine whether or not an annuity is right for you. This service is free with no strings attached. To get started, GO HERE.