The Pros And Cons Of Annuities

Perhaps no investment product evokes a broader range of reactions than retirement annuities. An annuity is a retirement investment sold by insurance companies. The underlying concept behind these insurance products—a guaranteed stream of income, often for the rest of one’s life—sounds tempting. The money in these long-term investments comes with various benefits and drawbacks.

Pros

Guaranteed income

The fact that an annuity generally provides income that cannot be outlived is perhaps the most compelling argument in its favor (though some only payout for a certain period). An annuity ensures that you will have something to supplement Social Security even if you live to be very old. The insurance company is responsible for providing the guaranteed income regardless of how long the annuity owner lives. However, that commitment is only as good as the insurance company that backs it up. It is one of the reasons why investors should only do business with insurers who have received excellent financial strength ratings from the essential independent rating agencies.

Customizable features

Annuity contracts are frequently adaptable to meet the needs of the buyer. A death benefit provision, for example, can assure that the annuity owner’s heirs receive at least something when the owner dies. A guaranteed minimum income benefit rider guarantees a set payout regardless of the performance of the mutual funds in a variable annuity. A joint and survivor annuity can give a surviving spouse continuous income. All of these amenities, however, come at an additional cost.

Tax-deferred growth

Annuities are a sort of investment that grows tax-deferred, which means that the money in your retirement savings plan is not taxed until you withdraw it. All of these pension plans offer the same benefit: tax deferral. Tax deferral is essentially an IRS benefit that allows taxpayers to postpone paying taxes until they take funds for personal use. When annuity income is received, it is taxed.

Money management assistance

Variable annuities may provide several professional money-management services, such as periodic portfolio rebalancing, for investors who prefer to delegate that responsibility.

Long term care insurance

Insurance companies have created supplements and riders to help cover the ever-increasing expense of long-term care. Some companies have even created tax-free annuities to pay for nursing homes, assisted living facilities, and home healthcare.

Cons

High fees

The majority of annuities do not impose sales charges at the outset. That may make them appear to be no-load investments, but it does not mean they are free of costs and charges. Annual maintenance and operational fees for annuities are usually much greater than the expenses of comparable mutual funds.

Lack of liquidity

Another source of concern is a lack of liquidity. If you try to withdraw from your annuity during the first few years of your contract, you will usually be charged a surrender charge. Typically, the surrender period lasts six to eight years, although it can be as long as ten years. These charges can be significant, making it impossible to back out of a deal once you’ve signed on the dotted line.

Tax penalty

If the annuity owner is under the age of 59½, any money taken out may be subject to a 10% early withdrawal penalty.