Are annuities good or bad?
Annuities are one of the most polarizing investment vehicles. Their advocates point to their tax advantages, the potential for lifetime guaranteed income and their advantages over conservative, fix-rate investments. Critics argue that annuities are too confusing, carry high fees and expenses, and provide very little liquidity.
But like a lot of things, the truth lies in between. For some people, annuities are a ideal way to save money for retirement and generate retirement income. For others, they are not a good choice.
Annuities are a good choice if:
You can receive an income stream that, when combined with other retirement accounts, provides enough to live a comfortable retirement.
Annuities should be part of an overall plan that begins with how much income you need to live the lifestyle you want in retirement. You begin with that number, then factor in income you will receive from Social Security, pensions, and other retirement accounts. If those other sources don’t quite add up to the retirement income you need, and you have the resources to make the premium payment, then an annuity can complement your other retirement accounts and fulfill your retirement plan.
You have maximized other tax-qualified retirement plans or you have a large sum of money to invest. IRAs and 401(k)s limit how much you can contribute each year. Annuities have no such limits. So if you’ve contributed a maximum to a tax-qualified plan and still have money you want to set aside, you can deposit as much as you want into an annuity — provided the insurance company has no premium limit. Though you don’t receive a tax deduction for the contribution into an annuity, the money inside the annuity grows tax deferred.
You want to save without exposing assets to the stock market. After some of the large market losses over the last 15 years, many retirees and those approaching retirement no longer have the stomach to handle the market roller coaster. Unless you purchase a variable annuity, the money inside an annuity can never be lost due to stock market declines.
Annuities are not a good choice if:
You have no other liquid assets. One of the downsides of annuities is that they provide little liquidity. This means if you really need the money you contributed to the annuity, you’ll pay a steep penalty for accessing it.
If you purchased an immediate annuity that begins making payouts right away, you’ve essentially surrendered control of the premium you paid to the insurance company. Once you begin receiving payouts, you are locked in a contract that pays a regular income stream.
If you purchased a deferred annuity, you have surrendered control of most of your contribution for the length of the surrender charge period. For example, if you bought an annuity with a 10-year surrender period, you are locked into the contract for those 10 years. Surrender the policy before that and you will pay a penalty. Most annuities do allow free withdrawals up to a certain percentage of your account value, commonly 10 percent. But that means if your account value is $100,000, you can only withdraw $10,000 a year without penalty.
Also keep in mind that because annuity account values grow tax-deferred, the IRS will impose a tax penalty for withdrawals made before age 59 1/2.
Because of these provisions, you should always have other liquid funds available in case of emergency.
You’re either very young or very old. When you buy an annuity, you’re exchanging a one-time or multiple premium payments for a stream of income, usually for a lifetime. They are primarily used to provide retirement income.
If you’re years away from retirement, you’ll be tying up money for several years before you can use it. While it’s good to save for retirement early in life, you’re more than likely better off to contribute funds in a 401(k) or IRA. They offer the same tax-deferred growth as annuities, but they also offer the added benefit of tax deductible contributions. Annuity premiums are not tax deductible.
If you’re much older, say age 80 or above, odds are you won’t receive the full benefits of an annuity because of your expected lifespan. You may be better off living off the money you have saved instead of committing it to an annuity.
You don’t understand what you’re buying. Certain types of annuities have many moving parts and features, and can therefore be difficult to understand. You should never commit a large sum of money to something unless you fully know what you are committing to. Otherwise, you may be unpleasantly surprised down the road and have little recourse to get out of the situation.