An annuity is a financial product sold by an insurance company. It’s an insurance contract. It works by you paying a premium, just like you would for any other insurance product. Then the company makes payments to you. These payments can be immediate or deferred.
Annuities are often used when planning for retirement. The lure of future guaranteed income is strong. But are they the right move for everyone? What are the pros and cons of purchasing an annuity?
Pros
Guaranteed Income for Life
There is a steady stream of income available for retirement. This income can last a lifetime. This makes it a great vehicle to avoid running out of money before you pass.Defer Taxes on Investments
Some annuities defer taxes until you start withdrawing. The theory is that your ordinary income will be lower in retirement than when you were working.The annuity allows you to grow your nest egg while postponing the inevitable taxes.
Avoids Probate for Heirs
Your annuity passes to your designated beneficiary without probate. It provides your beneficiary with immediate access to the funds.No Contribution Limits
An annuity doesn’t have contribution limits, so you’re free to add to your funds.The exception to this is qualified longevity annuity contracts (QLACs). But money in a QLAC is exempt from minimum distributions (RMD) until age 85.
Long-Term Care Insurance
Many people fear the high cost of long-term care. An annuity is a great way to pay for it. You can use your annuity to cover the cost of long-term care. This includes assistance with daily activities or nursing home care.Protects Against Stock Market Volatility
Your retirement is precious, and you may not want to take financial risks. Depending on your type of annuity, it is not subject to the stock market’s volatility. An annuity can offer a fixed rate that doesn’t fluctuate.Protection From Creditors and Bankruptcy
Generally, an annuity is free of liability from creditors and lawsuits. In most cases, an annuity can’t be garnished. An annuity’s income is usually not subject to creditor seizure.Cons
Losing Control of Investment
When investing in the stock market, you control where your money goes. You can move it around or even sell it if you want.The annuity company manages an annuity. You don’t have any control as to where your money is going. This can be disconcerting for many people. You’re operating on trust.
Early Withdrawal Penalty
There is a penalty if you have an early withdrawal from an annuity. If you withdraw the annuity before you’re 59½, you will not only have to pay the annuity company a surrender fee but you will be charged an early withdrawal penalty tax by the Internal Revenue Service.An annuity is a long-term commitment.
No Step-Up for Heirs
With an annuity there’s no step-up for your heirs as with stocks, bonds and mutual funds. This means that certain taxes won’t be reduced for your heirs after you pass.For example, if you purchased stock or other investment for $20,000 and it is worth $30,000 when you die, the IRS considers your heirs to have acquired the investment at $20,000. They won’t owe taxes if they turn around and sell it for $20,000. If they sell it two years later for $25,000, then they will owe taxes on the extra $5,000.
But if you have an annuity you bought for $20,000 and it has increased to $30,000 when you pass, your heirs will be taxed on the additional $10,000.
You’re passing on a tax liability to your heirs.
Start-Up Costs and Hidden Fees Add Up
Most annuities require a certain percentage of a downpayment. There are also expenses that you will need to pay. All of them have a mortality and expense fee. But other fees include but are not limited to:- contract maintenance charge
- subaccount fee
- investment transfer fee
- cost-of-living adjustment
- principal protection
- etc.
Annuities Have Low Returns
Generally, annuities have low returns. For example, the average fixed-indexed annuity has an average annualized return rate slightly over 3 percent. That’s similar to a CD’s return rate.Although lately volatile, historically, the stock market has generally come in at a 7 percent return rate. But with annuities, there is more stability and less risk on the return rate.
Annuities Not Insured by FDIC
Unlike banks or credit unions, annuities do not come under the Federal Deposit Insurance Corporation (FDIC). It’s important to check the insurance company’s financial strength ratings with both AM Best and Standard & Poor’s before purchasing.Income for Life at a Cost
An annuity is an insurance product, and like regular insurance, you are pooling your risk with other people buying annuities. The insurance company manages the risk, but you pay them to do this.You may not make any more money with an annuity than if you had invested it elsewhere, but your nest egg is generally protected and guarantees you long-term income.
There are several types of annuities to choose from. Consult a financial adviser and discuss if an annuity is the right course of action for you.
The Epoch Times Copyright © 2022 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
