Pros and Cons of Annuities
Anyone that has walked into a bank to renew a certificate of deposit has probably had some exposure to an annuity presentation. Bankers have been pitching fixed annuities as a ‘tax deferred alternative’ to CD’s for many years now. This unfortunate situation has somewhat tarnished the impression of the term and the very versatile investment product. There are a number of pros and cons of annuities; the truth is that there is very much more to these accounts than the fixed annuities pushed by bankers. Annuities are a complex and useful planning tool and these accounts do have upsides and downsides.
Tax Deferred Savings
As it turns out, the bankers were right about this. All annuities fall under tax deferred status with the IRS. The insurance company providing the annuity contract will handle the accounting and reporting. After-tax dollars can be deposited into the annuity account, then interest and earnings will be taxed upon withdrawal. Tax deferral is a tool for saving the amount of tax dollars a family pays over their lifetimes. The idea is that while working and having higher income, taxation is at a higher rate than it will likely be later in life.
Annuities Offer Options
There are nearly unlimited options for the investments within annuity contracts. Fixed annuities offer conservative investors the fixed rates they desire, typically similar to certificates or bonds. Variable annuities offer a range of investments from conservative to aggressive, including mutual funds and managed money strategies. Index annuities have investments in market indices such as the S&P 500. Annuities also offer options for depositing assets into the account. Account owners can make single lump sum deposits or choose to add funds to certain contracts whenever savings accumulate.
Another option is to make systematic or automatic deposits, saving money gradually over time. Another positive feature of annuity contracts is the option to select the type and method of payout. Annuity owners can choose to have payments of interest only, payments for a specific period of time, or even payments that will span one or two lifetimes (one life and spouses life). There are even options now that will guarantee lifetime payments without requiring annuitization, leaving an account’s cash value for family members or beneficiaries.
Guarantees and Protection
The benefits of getting guarantees and protection from annuities have increased tremendously in recent years. Annuity contracts are themselves a form of insurance, providing a guarantee of income for life if desired. This is essentially an insurance that the contract owner will have against outliving their assets. Through the purchase of ‘riders’ (add on features) there are many other protections available. For example, a variable annuity contract is available with downside protection. Consider the peace of mind and impact on investment strategy that comes with the ability to ride markets up but not down! Other riders can offer spousal protection, guaranteed growth, and many more benefits to account owners.
Using annuity contracts within a portfolio of investments can build guarantees and protection of income into a family financial plan. For example, a family could choose to invest a portion of their assets into a variable contract with the option for joint life payout and a guaranteed growth rider. Then, they could plan on a set amount of lifetime income (both spouses) with a chance to have more income than planned if market performance is better than expected.
Don't Just Shop, Implement a Solid Retirement Strategy
Purchasing an annuity is a big decision. Online research is a good start, but prudent investors should discuss all their options and risks with an independent financial advisor. Request a free, no-obligation consultation today, along with a report of current rates on brand-name annuities.Speak with an advisor over the phone about annuities for FREE.
What is the Downside to Annuities?
Annuity contracts do have downsides, most of which are restrictions and expenses. Annuity contracts should be used appropriately and as a component of a portfolio. Unless rare circumstances exist, only portions of assets should be committed to an annuity for a number of reasons. Also, it is important to understand that annuities fall into similar rules as retirement accounts when it comes to IRS considerations. Since the government allows the tax deferral, they have legislated a 10% penalty for withdrawals made before the age of 59 ½ by account owners. This may be considered as a con, though it is the trade off for tax savings.
Annuities Have Restrictions
The insurance company offering the contract may impose restrictions with issued annuity contracts. For example, many annuities have a CDSC (contingent deferred sales charge) if the funds are withdrawn earlier than expected. This is essentially a percentage fee charged to early withdrawals and normally starts higher and steps down each year. Other restrictions may exist for specific features of the annuities. For example, the variable annuity contracts that offer guarantees on growth and income may restrict the amount of income to a percentage of the contract value each year. Again, this is in exchange for the guarantee of lifetime income that may exceed the value of the account.
Fees and Expenses
There are fees and expenses associated with annuities, some of which apply only to riders or specific accounts. At their core, annuity contracts are an insurance against the risk of outliving your assets. Because the insurance company offers this protection, they charge ‘mortality’ expenses as well as administrative expenses with all annuities. Riders or features added to annuity contracts also have additional fees and costs. In most cases, the fees are charged as a percentage of the account value and added to the other expenses of the account. Though the term ‘fees’ has a very negative connotation, if value is provided (guarantees or protection) then is it really a downside? Keep perspective on what is provided for the money.
How do Annuities Compare to Other Investments?
When compared to savings accounts or certificates, fixed annuities are a tax deferred alternative with restrictions on withdrawals and an option for triggering lifetime income. When compared to IRA’s, annuities are quite similar with regard to tax deferral and investment choices. Key differences will be that the annuity has no limit to deposits and won’t have forced distributions for account owners at age 70 ½. When stacked up against mutual funds (this includes IRA’s with fund investments), the annuity can offer the same investment choice but will cost more. Remember that with the added expenses, value is provided. For the cost the annuity owner can get protection, guarantees, and can rely on lifetime income stream when needed. With funds, the account owner will have to rely on dividends or selling shares to get the income.
To find the best annuity products request a free, comprehensive quote comparision. Secure your retirement today, Get Started Now.