Annuities – Good Investment or Rip off?

 

Perhaps you’ve spoken to a friend at some point who sang the praises of an annuity and you thought…this sounds like a good idea.  Or maybe you need a way to create a guaranteed stream of income and think an annuity may provide that avenue. Maybe you are an avid learner on anything finance and have read about the high fees and commissions associated with them and wonder why anyone would consider one.

So, What is an Annuity?

An annuity is a contract with an insurance company that is designed to pay you a guaranteed stream of income either for life or a certain period of time. They typically provide tax deferred growth and there are no contribution limits like in 401(k)s or IRAs. They come in many shapes and sizes. Here is an overview of the main types.

Immediate vs. Deferred Annuity

You provide a lump sum of money which is exchanged for a monthly stream of income. It is considered an immediate annuity if that income begins immediately.  If it is invested for a while before you begin taking the income, then it is called deferred. These payments last for your lifetime (or a fixed term) and depending on how it is created, a portion of it may continue to your spouse upon your death (Joint and Survivor annuity). This is known as a Single Premium Immediate

Fixed vs. Variable Annuity

With annuities, you have to decide how you want your money to be invested within the contract. A fixed annuity’s growth is based on a stated interest rate so there is no market risk, but rates may be low.  However, you receive the same fixed payment over time. A variable annuity allows you to select from a variety of “sub-accounts” (which are similar to mutual funds) that represent different investments, such as bonds, stocks, and real estate investment trusts. These payments can go up or down depending on market performance and may be used if you are using this as an investment.

Do you want the ups without the downs?

A Fixed (Equity) Indexed Annuity provides you gains from the upside of the market without stressing about the downside when the market loses value. When the market does well, you share in some of the gains. But when the market loses value, your principal won’t lose value. This annuity offers lower risk (than a variable annuity) for some potential gain in market activity.

These all sound great. What’s the catch?

• You may not live long enough to recoup your premium
• It may take 8 years or more before you are able to pull money out without a fee
• High investment fees, surrender charges, and insurance charges
• These costs impact long term returns

Break Down These Fees for Me

Annuity fees will vary depending on the product. Usually there are insurance charges (pays for the guarantees that the insurance company provides), surrender charges (charges on an early withdrawal based on the time period of the policy or cancellation of the policy), investment fees (pays for the management of the underlying investment options), and fees for optional living benefits or optional death benefits.

Withdrawals from an annuity will reduce the value of your annuity, and withdrawals of taxable amounts are subject to ordinary income tax. Also, note that withdrawals prior to age 59½ may be subject to a 10% Federal tax penalty.

Good or Bad Idea?

These may make sense when you want to create stream of income that you cannot outlive, have maxed out all other tax deferred accounts, or have a lot of liability risk and need the asset protection (varies by state). 

However, due to the high fees, this is usually not the best way to build wealth or provide legacy.  This plus the fact that you’ve lost control over that principal are some of the downsides to annuities. Also, there are other ways to create your own stream of income without paying these high fees.

The big draw of annuities is the guarantee they provide, either against market fluctuation or for income. But you pay a premium for that guaranteed insurance. Is that premium worth the guarantee?

Speak with your Allgen Financial Advisor to see if this is the right solution for you.

Written by Teresa Talton with Allgen Financial Advisors, Inc. 

 

 

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