Do Annuities Make Good Investments? What to Consider Before Purchasing

by Jessica Sommerfield · 0 comments

In a recent post’s comment section a reader expressed interest in seeing a article about annuities. While I don’t know much about annuities from personal experience, since I have yet to explore many of the possible retirement options, I did a little research on the subject.

While you’ll want to discuss the exact terms of an annuity with your personal broker, insurance agent, or direct-sale company, this will hopefully give you a general idea of whether an annuity is a good retirement option for your needs.

Do annuities make good investments? How are they used for retirement income later in life?

What is an annuity?

An annuity is a type of retirement savings usually offered through insurance companies and, in one way or another, guarantees a steady income after you retire, whether in monthly, quarterly, or yearly pay-outs.

There are various type of annuities, including:

  • Fixed or variable
  • Deferred or immediate
  • Period certain
  • Lifetime
  • Joint/survivor

While these terms can be combined to create your own personal cocktail of retirement needs, the features which make the biggest difference are: whether or not you’ll be receiving payouts immediately or in the future, and whether you prefer a guaranteed payment amount or an amount based on stock market performance.

How do annuities differ from other investment accounts?

Annuities share common traits with other retirement options, such as 401Ks and IRAs, in that they allow you to set aside money for retirement on a tax-deferred or tax-free basis.

However, unlike 401Ks and some IRAs, the principal (original) part of your investment withdrawals are never subject to tax…only their earnings. Furthermore, there’s no limit on how much money you can invest in an annuity, unlike the caps that are placed on other options.

What are the advantages and disadvantages to an annuity?

Annuities are especially helpful for three reasons.

  1. If you’ve already maxed out your investment ceilings in 401Ks and IRAs
  2. Have under-prepared for your retirement and need to catch up
  3. Are approaching retirement and need immediate guarantee of income

If you’ve already invested in a deferred annuity, you can change the terms to an immediate when you decide to start withdrawing money. Those who want a guarantee of income for a spouse or dependent after they’ve died are also attracted to annuities based on their options for guaranteed payments within a fixed year range or even for the lifetime of the survivor.

These features make them similar to life insurance in some respects.

The first bad news you’ll hear about annuities is their expense-to-benefit ratio. Annuities that are sold by insurance companies use agents who receive up to 10% commission on annuity sales, and up to 3% yearly maintenance fees.

If you withdraw within the first 7-8 years of investing in an annuity, you’ll probably be subject to a surrender charge, similar to the early withdrawal penalties associated with 401Ks and IRAs.

Furthermore, if you choose a variable instead of a fixed annuity, you run the risk that the investment performance will not outpace the high fees you’ll be charged for it.

Are there alternatives to annuities?

The main advantage of annuities is their ability to provide immediate and set income throughout retirement; if you’re in the place in life where you need security and dependability, the advantages of this option may outweigh the disadvantages.

Otherwise, if you have a while to go before you retire, consider mutual or index funds — investment accounts that carry lower annual feeds and might yield more money while you don’t mind the risk.

If you’re thinking about purchasing an annuity, you should consider that it will probably be a lot cheaper to go through a direct-sales company. These companies design annuities that don’t charge annual fees or involve copious penalties — think of them as the discount dealer of annuities rather than the traditional privately-owned speciality store.

From these explanations, keep in mind that annuities aren’t for everyone, but neither are they always a bad idea. It all depends on your individual needs, so talk to your insurance company or a direct sales company for more expert and customized insight.

Have you purchased an annuity as part of your retirement income? What was your experience?

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