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Investing is risky. Not investing is also risky. Right or wrong, as people contemplate their need for retirement income, many venture into the world of annuities. The 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 insurance vehicles that frequently come with significant fees, restrictions, and risks that may diminish their perceived safety. Unless all the details are clearly understood, annuities may 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 while 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 also limit the return or success that you as the owner 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 approach 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 If assets are withdrawn early or exceed an amount specified in the contract, surrender fees may come into play that can be extremely high.
  • 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 often is 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 linkage to the stock market – direct or indirect – causing their values to 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 as ordinary income, rather than more tax friendly capital gains.
  • 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 a dollar tomorrow. Annuity income is usually not adjusted for inflation. Therefore, 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 an investor’s dollars are handled. These provisions can make you wonder if the insurance company still understands it is your money that you are trying to access!

Each investor must reach his or her own conclusions on whether annuities are worth the complexity and a fit for their plan. While they may appear safe, drawbacks exist that are not always readily apparent. Other investments certainly exist that can provide less costly and less restrictive ways to accomplish similar objectives. Be sure to do your homework, ask questions, develop a plan aligned with your goals, make decisions within the context of that plan and, of course, stay diversified.


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