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Weighing Pros and Cons of Annuities

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Annuities: Pros and Cons

As one of many retirement investments you can make, annuities both have advantages and disadvantages. Outlined below are some of the features and characteristics common to most annuities to help you decide whether investing in an annuity would work for you.

Advantages

(+) Unlimited Tax-Deferred Investment

While annuities work the same as other retirement plans, they do not have an annual contribution limit. You can put as much money into an annuity as you wish, which is good news for those who are near retirement and want to catch up. Funds you invest will also compound every year tax-free so all of your dollars continue to work for you wholly.

(+) Steady Retirement Income

While you can choose to cash out your annuity for a lump sum, most retirees prefer a steady stream of income that could either last a lifetime or for a number of years. This works well with other retirement income from pension plans or Social Security.

(+) Multiple Investment Choices

Annuities can also work for individuals who have a high risk tolerance and who want to have a say on how their money will be invested. If this is you, you can look into variable annuities because they allow multiple investment choices such as fixed accounts, money markets, domestic, international and sector funds so investors can use different strategies.

(+) Optional Living Benefits and Death Benefits

Variable annuities also have optional living benefits and death benefits. Living benefits provide either higher guaranteed returns or guaranteed lifetime income even if the annuity balance becomes zero.

Death benefits works similar to life insurance policies, in that, when you die, your beneficiaries receive the total premiums you invested at minimum, or the highest contract anniversary.


Disadvantages

(-) Commissions and Annual Fees

Most annuities are sold by insurance agents who may charge commissions as high as 10%. In addition, insurers can charge high annual fees to manage variable annuities, around 2% to 3% per year. Make sure to ask your agent to clearly outline all charges so you won’t be surprised by any hidden fees.

(-) Surrender Charges

Withdrawing any amount from an annuity within the first six to eight years of buying it will accrue a surrender charge, which is usually 7% of the account balance. This percentage declines point by point over the years, and it’s recommended that you leave your funds in an annuity until the surrender charge reaches zero. More so, you may be also obliged to pay penalties if you decide to make a withdrawal before age 59 ½.


Other Important Considerations

Apart from the pros and cons of annuities, there are other important factors that you need to consider before deciding to purchase any type of policy.

The Type of Annuity

For those who are looking a cost-effective way to incorporate annuities in their retirement plans, you need to consider the type of contract you intend to purchase.

Typically, the more complex the annuity is, the more fees will be charged, thus a higher cost. A single-premium annuity that’s set to provide guaranteed payouts will be more affordable than a variable annuity that allows you to invest in other investment vehicles. This is because annuities that have more comprehensive features entail more fees and commissions.

Providers

There are guarantee associations in each state that insure a portion of your coverage, typically by up to 150,000 to 300,000. But at the end of the day, your annuity will still only be as good as its provider. There’s no FDIC to fall back on in case the provider goes under and becomes unable to perform their financial obligation to you when time for annuitization comes.

Though it’s comforting to know that a portion of your money is insured no matter what, remember that you purchase an annuity with the intention of having a steady stream of income, and not just to receive a limited amount in the future. That’s why experts always advise purchasing annuities from companies with good and consistent performance, high ratings, and strong financial capability.

Understanding these pros and cons should help you decide whether an annuity is a good part of your retirement strategy. If so, take a look at our handy pre-buying checklist to determine how ready you are in investing in an annuity.

Helpful Resources:

Variable Annuities: What you Should Know, US Securities and Exchange Commission

5 Tips for Buying an Immediate Annuity, CBS News

Ultimate Guide to Retirement: Annuities, CNN Money


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