Are Annuities Good or Bad?
Annuities are neither good nor bad, but they aren’t for everyone. At some point in your retirement plan annuities may make an excellent fit. Here’s the rundown on annuities, including the pros and cons.
Pros
Annuities Are Safe. Annuities are perhaps the most safe investment money can buy. Since you’re protected against downside risk, and have some opportunities for capital appreciation, annuities are an excellent choice when safety matters most.
Annuities are Consistent. No other investment option allows future retirees to know exactly how much money they’ll get each month in retirement benefits, not even entitlement programs like social security which seem to have higher and higher age requirements as time goes on. Before purchasing an annuity, you’ll know exactly how much you’ll receive upon retiring, and that couldn’t be a better thing to know. Also make sure you shop around for the best annuity rates before committing as annuity rates can vary by provider. Consistency is key when it comes to your retirement.
Hands off Investing. Many investors flock to annuities because they’re largely hands off. You don’t have to adjust your portfolio weighting, nor do you need to check in or do any real research after the product is purchased. If you’re the kind of person who can’t be bothered to worry about your retirement plan, I’m sure a financial planner would be more than happy to manage it for you via an annuity.
Tax Free Growth. Capital invested in an annuity grows tax free until withdrawal, allowing you to compound your earnings without a tax burden. Compare that to individual stock picking outside a traditional retirement account like a 401k or IRA and you’ll see that your funds will grow faster in an annuity than in other, taxed investments.
Cons
Annuities Can Be Expensive. Don’t be fooled, safety, security, and consistency do have their price. Often, an annuity will cost you roughly 2-2.5% of your investment per year, well in line with high fee mutual funds and several times more expensive than an exchange-traded fund.
Surrender charges, fees on money withdrawn before reaching a certain time table (usually a decade) will cost as much as 7% of the amount of capital withdrawn. Also, expect to pay a few percentage points up front, which helps subsidize the financial planner selling you the annuity.
Annuities May Underperform. Annuities will certainly never drop in value, but they’re unlikely to beat any stock funds. Generally, annuities are good for about 1.5-2% more per year than the return of other fixed income investments like bonds. That return, though good, isn’t great, and an investor with a long term horizon is probably better off with a stock portfolio.
Tax Free Growth has Disadvantages. The ability to grow your wealth tax-free, until you withdraw of course, also means that instead of paying long term capital gains taxes, you’ll be paying personal income taxes. Annuities, as far as taxes go, are considered income rather than a capital gain, and the difference can be as much as 20%. The good news, or bad depending on how you look at it, is that capital gains taxes are on the rise, and by the time you retire, capital gains and income taxes could be equal.