One question we get asked frequently is whether or not to buy an annuity. Since there are many factors to consider when answering this question, this article isn’t intended to provide you with a “yes” or “no” answer. Instead, this is meant to provide you with additional information. If you have a better understanding of annuities, it will help you make a more informed decision.
Let’s start with what an annuity is and is not. An annuity is a contract issued by an insurance company. It is not an investment like a stock or a mutual fund. Since they are insurance company-issued contracts, they provide certain guarantees (backed by the financial strength of the insurance company), as opposed to a pure investment. An annuity is designed to provide you with income, whether it be immediate, in the future, for your lifetime, or for a specific period of time. This is the main reason to buy an annuity: income. Much like a pension or social security pays you for as long as you live, an annuity can be designed to do the same thing. No other vehicle can provide this, which is why annuities should never be compared to traditional investments.
What are the typical features of an annuity? They typically do not have a sales charge to buy them, but impose a surrender charge for a designated period of time should you withdraw money early. The benefit is that all of your deposit is working for you from day one. The surrender charge is imposed because the company has obvious expenses in setting up the contract, as well as commissions (if not fee-based) to the person who sold you the contract. The annuity can contain riders that may guarantee returns for future income purposes, death benefits, or principal protection. Often, these riders come with an additional fee. Also, annuities have named beneficiaries, which bypass your will, unless you name your estate as the beneficiary, which is not frequently recommended.
What are the pros of an annuity?
1. Lifetime income
Only an annuity will typically provide you with income for life, regardless of whether or not you run out of principal. This is clearly the primary selling point of an annuity.
2. Principal protection
Some annuities will provide protection against a loss of principal, which many retirees favor.
3. Tax deferral
Interest earned in annuities, unlike other non-IRA investments, is not taxable until withdrawn. Be careful, however. When the withdrawals are made, the interest comes out first and is taxed as ordinary income. This can be less favorable than traditional investments, which are taxed as a capital gain.
4. Beneficiary designations
Naming a beneficiary can allow the death benefit proceeds to avoid probate.
What are the disadvantages of an annuity?
1. Annuities are complex
They are poorly understood by most people, often due to their complexity and multitude of moving parts.
2. Taxation
While the tax deferral of an annuity is a selling point, as mentioned earlier, income coming out of an annuity may not be as favorable as traditional investments.
3. Potentially muted returns
While we all love guarantees, sometimes those guarantees come at a price, and one of the possible costs is that an annuity may not earn as much as traditional investments. Retirees may not care as much about this as younger investors may, because they may be more concerned with the protection of principal, but it is worth noting.
4. Fees
Some annuities, typically variable annuities, can become very expensive if you add multiple riders to the contracts. Remember, all those bells and whistles can be great, but they come at a price. It can be a very high price, so be careful what you add onto your annuity contract.
Seeing annuities through this lens can hopefully help you decide if an annuity is a suitable product for you to consider purchasing.
Fixed Index Annuities are not a direct investment in the stock market. They are long-term insurance products with guarantees backed by the issuing company. They provide the potential for interest to be credited based in part on the performance of specific indices, without the risk of loss of premium due to market downturns or fluctuation. Fixed Index Annuities are designed for long-term investors. These annuities do not participate directly in any stock or equity investments. You aren’t buying shares of stock or an index. Dividends paid on the stocks on which the indexes are based don’t increase your annuity earnings. Interest crediting may be based on one or more different methodologies. Please read the product prospectus for details. If you take money from your annuity early, you may lose some or all of your credited interest. If you take out all (a full surrender) or part (a partial surrender) of the money, you may also have to pay a surrender charge. The amount of the charge depends on how long you’ve had the annuity and how much you withdraw. They may not be appropriate for all clients. Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view the form CRS, visit https://bit.ly/KF-Disclosures.
Eric is President and founder of Reich Asset Management, LLC. He relies on his 25 years of experience to help clients have an enjoyable retirement. He is a Certified Financial Planner™ and Certified Investment Management AnalystSM (CIMA®) and has earned his Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) designations.
