Annuities aren’t necessarily a bad idea, but you ought to understand the risks beforehand. As a complex and often confusing investment, deciding whether to pour your savings into an annuity, particularly a variable or indexed one, should be taken with caution. Here are the key advantages and disadvantages you need to know.
Key Advantages of Annuities
Guaranteed Stream of Income in Retirement
We all want a worry-free retirement. And that’s why an annuity sounds so enticing. In exchange for some cash, an insurance company promises you a guaranteed stream of income for the rest of your life. You can choose to receive payouts straight away (immediate annuity) or at some stage in the future (deferred annuity). Obviously, there’s a great deal of peace of mind associated with this agreement, especially when compared with a traditional stock and bond portfolio that is vulnerable to the market and can fluctuate over time.
Opportunities for Tax Deferral
Annuities are the only investment classed with tax-deferred status. This means that any money invested into an annuity grows without tax until you withdraw it. There are also no limits on the amount of money you can invest in an annuity, making these contracts a popular choice for wealthy retirees looking to shelter their assets from the taxation office.
Key Disadvantage of Annuities
High Commissions and Fees
The promise of lifelong cash can blur our vision and inhibit our ability to foresee the potentially high costs of an annuity. Keep in mind, particularly during sales pitches, that annuities have the most notoriously expensive commissions and fees. In fact, it’s not uncommon for a salesperson to receive a 10% commission, and some annuities have annual fees that increase as your annuity grows. For this reason, it’s generally a good idea to discuss annuities directly with an insurance company instead of buying through a third party salesperson.
Stiff Surrender Penalties
When considering an annuity, make sure you have the funds to afford payments for the remainder of your life, as most annuity contracts have hefty surrender penalties for early withdrawal. Also, if you end your contract before the age of 59 and a half, you’ll likely incur an additional 10% premature distribution fee.
Proceed with Caution
Annuities can provide tremendous benefits when used correctly. However, despite all their promise, annuities remain inherently complex vehicles of investment that should be used with a high degree of discretion.