Five reasons young investors should avoid annuities
While annuities are primarily bought by retirees and those approaching retirement, they are starting to find a market with younger investors. People in their 40s and even some millennials are finding value in annuities.
However, annuities aren’t for everybody. Here are five reasons why an annuity may not be of value to younger investors:
You haven’t maximized other investment opportunities
Most financial experts believe you should contribute the maximum to a tax-qualified retirement plan before investing in other vehicles. That’s because 401(k)s and IRAs provide a tax deduction for contributions and the accounts grow on a tax-deferred basis. You don’t pay taxes on the money in those accounts until you begin taking withdrawals. Also, employer-sponsored plans often contribute matching funds.
Advisors also claim that over the long term, equity investments will generate more savings and more potential income than a long-term annuity, so investing in mutual funds and exchange-traded funds may be a better investment option if you’re younger.
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 purchase a deferred annuity, you surrender 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 ten 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 a fair amount of debt
If you have student loans, credit card debt or other loan balances, you may be better off using the extra money to pay down those debts and minimize interest charges instead of tying up that money in an annuity for a lengthy period.
You won’t earn much in the current interest rate environment
Fixed annuities are interest-rate sensitive, meaning the rate in which they accumulate assets will rise an fall based on the prevailing interest rate environment. Because rates have been so long for so long, fixed annuities are paying modest rates, though these rates are guaranteed. Fixed indexed annuities will do somewhat better, but the caps and spreads that limit upside growth are also considerably low due to the current rate environment.
You can benefit by waiting to purchase an annuity
If you dutifully put aside money in your 401(k) for the bulk of your career and earn employer matches, you could have a substantial amount saved later in life. Instead of leaving that money in a 401(k) where it may lose value due to market losses, many people roll over their retirement plan balances into an annuity.
The main advantage to rolling over 401(k) funds into an annuity is the peace of mind of having a guaranteed income stream and not having your retirement funds exposed to the whims of the stock market.
For example, a current 60-year-old with a $500,000 in a 401(k) can roll over that money into a fixed immediate annuity paying lifetime income for just the one life and receive an estimated $2,500 per month for the rest of his or her life – guaranteed.