If you are worried about paying for retirement, it is worth evaluating the pros and cons of annuities.
Annuities are a great way to help provide guaranteed lifetime income in retirement while hedging against inflation and other financial woes. Which is why financial advisors and Fiduciaries alike have long recommended that their clients invest retirement money in annuities. However, the criticism leveled at this practice usually focuses on high commissions paid to salespeople, along with stiff fees charged to annuity owners year after year.
Here’s a rundown of the pros and cons of annuities, compared with other ways to invest for retirement.
How Annuities Work
An annuity is a contract between an individual and an insurance company. Annuities are investment vehicles structured to help pay a stream of income for a preset number of years, such as 10 or 20; or the life of the annuity owner. When the owner dies, any money remaining in the account typically belongs to the insurance company. However, even if they live to be over 100 years old, the insurance company still has to keep those regular payments coming.
An immediate annuity begins making monthly income payments almost instantly. A deferred annuity starts making payments at some point in the future, typically during retirement. The dollar amount of those payments depends on various factors, including the balance in the account and the age of the investor.
Pros and Cons of Annuities
Annuities can be fixed or variable. In a fixed annuity, the insurer guarantees to pay a specified rate of return on the investor’s money. In a variable annuity, the insurer invests the money in a portfolio of mutual funds chosen by the investor, and the return will fluctuate based on their performance. Here’s a look at the pros and cons of annuities.
Pro – Guaranteed Income
An insurance company is responsible for paying the income it has promised, regardless of how long the annuity owner lives. The company’s promise is only as good as the insurer behind it, which is why investors should only do business with companies that receive high ratings for financial strength from the major independent ratings agencies.
Pros – Assistance with Money Management
Variable annuities may offer a number of professional money-management features for investors who’d rather leave that work to someone else. These include periodic portfolio rebalancing and the ability to invest in a range of asset classes, including stocks, bonds and real estate.
These features can be particularly appealing to those who are looking for an easy way to invest in a diversified portfolio without having to do all the legwork themselves.
Pro – Customizable Features
Annuity contracts can be customized to suit a buyer’s needs. For example, a death benefit provision can help ensure that the annuity owner’s heirs will receive at least the original amount of money invested in the annuity in the event of his or her death.
A guaranteed minimum income benefit rider helps ensure a certain payout regardless of how well the mutual funds in a variable annuity perform. A joint and survivor annuity provides continued income for a surviving spouse, but it also costs more.
Pros – Inflation Protection
As mentioned in the previous point, you can customize annuities to help ensure that your monthly paycheck will keep pace with the cost of living. This is critically important because inflation can have a devastating effect on your assets. The downside of an add-on like inflation protection is that it will cost more – either in initial costs or in lower payouts when you begin to collect.
Cons – High Commissions
Annuities can be a great tool for investors. But it’s important to know the difference between annuities and mutual funds, and why the commissions for selling annuities are almost always higher than those for selling mutual funds.
Say an investor rolls a $500,000 balance in their 401(k) into an individual retirement account (IRA). If that money is invested in mutual funds, the financial advisor may charge roughly 2% as commission. This is if it’s invested in an annuity that holds the same or similar mutual funds. However, the advisor could always charge more.
Because annuities are more profitable for advisors, many of them will direct their clients into them. A $500,000 rollover into mutual funds would pay the advisor a $10,000 commission at most, while the same rollover into an annuity could easily pay the advisor $25,000 to $35,000 commission. Because of this, it is important to get multiple quotes from different companies before deciding on an annuity provider.
Cons – Tax Penalties
If you are under age 59½ and receive the annuity payments, you may have to pay a 10% early withdrawal penalty on any money you take out. This is in addition to the income tax on the withdrawal.
Income received from a pension or annuity contract is fully taxable if you have no investment in the contract. This can happen if any of the following situations apply:
- You didn’t contribute any after-tax amounts for your pension or annuity
- Your employer didn’t withhold after-tax contributions from your salary, or
- You received all of your after-tax contributions (your investment in the contract) tax-free in prior years
Cons – Surrender Charges
If an annuity owner needs to get money out of the annuity before a certain period of time has elapsed (typically six to eight years, but sometimes longer), they may be subject to hefty surrender fees charged by the insurer.
Surrender charges are fees that insurance companies charge investors who want to withdraw their money from an annuity before it matures. These fees can run as high as 10% of your original investment amount and are often charged in addition to any income tax you owe on the withdrawal.
Though less risky, annuities generally yield lower returns than other investment products, and often come with high fees, so it’s important to do your research before buying.
Final Thoughts
As an investor, you want to help sure that your money is safe. You don’t want to lose any of it and you definitely don’t want to lose it all. At Johnson Wealth and Income Management, our financial advisors and Fiduciaries are equipped to handle any of your financial questions when it comes to investing for the future. We can help you with your financial planning so you can have peace of mind while pursuing your life goals.
Our advisors are committed to breaking down the common misconceptions about retirement by educating our clients and communities through workshops on topics related to more conservative investment alternatives. We also offer a wealth of services custom-designed to help you get the most from your retirement.
If you want professional guidance to help make the best out of your annuity investments, contact us here today.
All written content on this site is for informational purposes only. Opinions expressed herein are solely those of Johnson Wealth & Income Management and our editorial staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. Investing involves risk. There is always the potential of losing money when you invest in securities. Asset allocation, diversification and rebalancing do not ensure a profit or help protect against loss in declining markets. All information and ideas should be discussed in detail with your individual advisor prior to implementation. The presence of this website, and the material contained within, shall in no way be construed or interpreted as a solicitation or recommendation for the purchase or sale of any security or investment strategy. In addition, the presence of this website should not be interpreted as a solicitation for Investment Advisory Services to any residents of states where otherwise legally permitted to conduct business. Fee-based financial planning and Investment Advisory Services are offered by Sound Income Strategies, LLC, an SEC Registered Investment Advisory firm. Johnson Wealth & Income Management and Sound Income Strategies LLC are not associated entities. Johnson Wealth & Income Management is a franchisee of the Retirement Income Store. The Retirement Income Store and Sound Income Strategies LLC are associated entities. © 2021 Sound Income Strategies.
