when you should avoid annuities

When you should avoid annuities

Like all investment products, annuities are not for everybody nor are they suitable for all situations.

Here are five reasons why you may want to avoid buying annuities or why they may not work well for your needs:

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 have significant wealth

The primary purpose of an annuity is to turn a premium payment into a lifetime stream of income that cannot be outlived. If you have significant wealth, you likely do not have to worry about running out of money before you pass away.

As an investment product, annuities will charge higher fees than other conservative investments and will likely not generate the return of equities.

Another reason wealthy individuals should avoid annuities is because they won’t necessarily benefit from the product’s tax deferral. Annuity income is taxed as regular income, so those in the highest income tax brackets will pay the highest percentage of taxes when they receive annuity payments. On the other hand, investments in stocks and mutual funds get taxed at a lower capital gains tax rate and only after an asset is sold.

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.

Before you sign the contract, you should understand :

  • The contract’s surrender period. Know how long you have to hold onto the contract without penalty and how much the penalties are if you do need to cancel.
  • How much your policy earns in interest and how that rate is determined.
  • How much income you will receive from your annuity and how that amount will be determined.
  • Your liquidity options.
  • Your death benefit options.

If you are confused about any of the annuity’s provisions, take some time to review the annuity’s certificate of disclosure, a document that summarizes the contract. Discuss it with somebody you trust who can explain it to you and make you feel comfortable buying it or can provide good reasons you shouldn’t.

You’re feeling too much pressure from the agent

Most insurance and annuity agents do business with a high amount of integrity and try to sell clients the product that fits their situation best. However, as with any profession, there are those who don’t always serve their clients’ best interests.

If the agent trying to sell the annuity does any of the following, walk away and look for another adviser:

  • Pushes one annuity without showing options, especially if you ask for other choices. In this situation, the agent may be trying to collect a bonus for selling a specific annuity without attempting to find the right product for your needs.
  • Claims you need to act now to get a special rate. Because of the long-term commitment, buying an annuity should not be a rush decision.
  • Has trouble answering your questions. Sometimes an annuity can be so confusing, even the agent selling it doesn’t fully understand it. If the agent struggles to answer basic questions, he might not know whether it’s right for you.