Investing is risky. Not investing is also risky. So, what’s a person to do in seeking a strong financial future and timely retirement? Right or wrong, many venture into the world of annuities. Their promise of a stream of income when your working years are complete can be appealing and comforting.
These products are often sold under the premise that they can take the risk out of investing. In reality, annuities are complex investment vehicles that frequently come with significant fees, restrictions, and risks that may diminish their perceived safety. Unless all the details are clearly understood, annuities can pose more problems than solutions for investors.
Whether you have an annuity in your portfolio or are considering purchasing one, do yourself a favor by thoroughly researching what this means within the context of your overall financial plan. Here are some general questions and considerations to make in going through this evaluation process:
• Type of annuity – Fixed, Indexed and Variable annuities all have different risks and benefits. While the selling point may be a floor to potential losses, most limit the return or success the annuity and you, as the investor, can experience.
• Read the contract – Sound like fun? This is daunting, yet critical. Every annuity is different and comes with restrictions and costs you must understand fully. There is a reason the SEC has imposed significant regulations on sales tactics of variable annuities, in particular, due to a bevy of complaints and lawsuits from customers.
• Expenses – Most annuities have several layers of fees that can be upward of 3-4% annually, sometimes even higher. These expenses often come with obscure labeling such as mortality risk, administrative fees, benefit riders, fund expenses, and miscellaneous expenses. If assets are withdrawn early or exceed an amount specified in the contract, surrender fees may come into play that can be as high as 15-20%.
• Extras – Riders can be attached to the policy, but carry significant additional cost. They add benefits that may not be necessary, or appropriate for your situation.
• Withdrawal Provisions – Withdrawing funds on your terms is often not a luxury afforded the purchaser. Think twice if you might need access to assets in the future beyond what the annuity contract would allow.
• Performance – Indexed and variable annuities have some exposure to the stock market –direct or indirect – their values, therefore, fluctuate. Contractual provisions dictate how much market movement can hurt or help your future distributions.
• Taxable impact – Be sure to talk with your tax advisor when considering an annuity purchase or taking distributions from one you own. Withdrawals are typically taxed at ordinary income rates, not the more friendly capital gains rates.
• Situated – Holding a deferred annuity within a traditional IRA or 401(k) account provides no additional tax advantage. If this is your situation, you are likely paying extra for tax-deferred status that is redundant.
• Inflation – A dollar today is not worth the same as tomorrow. Annuity income is usually not adjusted for inflation, thus the distributions you plan on receiving may not have the same purchasing power in the future.
• Survivor benefit – Be sure you understand what happens if the annuity holder dies. Outcomes vary wildly between annuity products, both in how much a beneficiary may receive and over what time frame.
• Flexibility – Annuities can be relatively inflexible investment vehicles. They are insurance products with contractual provisions dictating how the investor’s dollars are handled. Your money can become not so much your money anymore!
Each investor must reach their own conclusions on whether annuities are worth their complexity and a fit for their plan. While they may seem safe, drawbacks exist that are not always readily apparent. Other investments certainly exist that can provide less costly and restrictive ways to accomplish similar objectives. Again, just be sure to do your homework, ask questions, develop a plan with goals, make decisions within the context of that plan…and, of course, stay diversified.
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