In an unstable economy where interest rates are low, many investors turn to annuities as a means of guaranteeing a stable income for their retirement years. But do annuities effectively fill that need? Most experts respond with a resounding, "It depends." Annuities come in a broad range of varieties, with an array of optional riders, and vast numbers of sub-accounts, all of which help investors to either tailor a product--or get lost in confusion.
- Guaranteed Income: Some annuities can offer you a guaranteed income for the rest of your life, no matter how long you live.
- Death Benefit: Most annuities offer a death benefit to your survivors, usually in the amount of what remains of your initial investment. For example, if you invest $100,000 and live only long enough to have been paid 10 percent in retirement income benefits, your survivors receive $90,000.
- Increased Payments: Not only will some annuities guarantee a minimum level of income, regardless of asset fluctuations, they will increase your income if assets perform well. In some cases you can even lock in the increased income level.
- Tax Advantages: Even if you have maxed out your 401K contributions, you may still be able to make tax deferred contributions to an annuity. It is also likely that you will be taxed at lower rates when you receive your payouts.
- Reasonable Fees: While some fees may be excessive, typical annuity fees are around four percent annually. Some are much lower.
- Inflation Index: Some annuities offer riders that allow you to ensure that your income keeps pace with inflation.
- Age: Most people invest in annuities between the ages of 50 and 70. If you didn't start planning for retirement at the age of 20, annuities may be a way to make up some lost ground.
- State Protection: While annuity investments are not insured by the FDIC, each state provides a level of protection for your investment capital.
Some financial experts steer investors away from annuities for a variety of reasons, including:
- Complexity: The rules and calculations are highly complex, making it very easy to purchase a product that isn't the best one for your individual needs, according to Jason Alderman, Senior Director at Visa, in his article Annuities 101.
- Fees: Annuities can be fraught with fees. There are front-end fees, back-end fees, broker commissions, rider fees, and sub-account fees, making it difficult to grasp the precise cost of the investment.
- Restrictions: Read the fine print. Numerous exclusions and restrictions are included in annuity contracts, so you need to make sure you clearly understand all the aspects of any annuity product you purchase.
- Payout Calculations: How the payouts are calculated for your retirement income stream vary widely, making cost/benefit analysis a challenge.
- Inflation: Annuities are not all necessarily indexed to keep pace with inflation.
- Payout Terms: Some annuities provide income for life, while others pay income for a period of 10 or 20 years. Still others have an "age-out" feature, meaning that the contract expires when you reach a certain age. You don't want any income surprises in your later years.
- Surrender Charges: If you discover you have purchased the wrong product, you can't simply roll it over into another. You have to back out of the product, and surrender charges can be costly.
- Survivorship: Some annuities do not provide for your spouse or other heirs after your death.
- Company Stability: Annuities are offered by life insurance companies. If the company from which your product is purchased goes out of business, you stand to lose a substantial amount of money.
- Asset Performance: Investors may choose annuities because of their reputed stability and to flee the uncertainty of Wall Street, but these products are not immune. While it's true that risk is spread, the ups and downs of the companies contained in the sub-accounts are still sensitive to stock market fluctuations. How the assets perform can still impact your long-term income.
- Broker Trust: Most people who invest in annuities do so through brokers, trusting that person to carefully manage their resources. Even if your broker is highly skilled and has your best interest at heart, you are buying into a contract, not a relationship. Your account could be reassigned, or that person could leave the company.
If you think an annuity might be right for you, consider these tips as you make your decision:
- Because of mortality credits, those who live the longest reap the greatest share of the benefits. If you are healthy and have longevity in your genes, an annuity is likely a better investment for you than it is for someone with serious medical conditions.
- Check with the Insurance Guarantee Association to determine how much of your investment is insured by the state. Consider spreading your investment across multiple annuities to ensure a higher level of protection.
- Give careful consideration to any riders offered with an annuity. Though they may add fees, they may also add substantially to your quality of life during your retirement years.
- Ensure that the company providing your annuity has high ratings from A.M. Best, Standard & Poor, and/or Weiss Ratings.
- Consult with a tax expert and an unbiased financial advisor or attorney before committing funds to an annuity.
It's Your Future
As medical technologies advance and lifespans lengthen, financial considerations become increasingly important. Whether you invest in an annuity or decide on another financial vehicle, research your options carefully and give yourself time to make a thoughtful decision.