If You Hate Annuities, You May Not Understand Them
Three tips to help you avoid making an annuity mistake.
- (opens in new tab)
- (opens in new tab)
- (opens in new tab)
- Newsletter sign up Newsletter
No investment or insurance strategy is more polarizing than annuities.
Some financial professionals love them. Some hate them. Others claim to hate them — but only certain kinds. All of which is extremely confusing for the average investor.
The bottom line is that annuities can be a wonderful tool for those looking to generate guaranteed retirement income. They also can be a real headache if used improperly or if you’re sold one as a stand-alone solution rather than as part of an overall investment plan. Plus, they can be complicated. The contracts can be dense, inflexible and littered with legalese.
Subscribe to Kiplinger’s Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Types of Annuities
To add to the complexity, there are several types of annuities, each with its own pros and cons, depending on an investor’s specific needs. They include:
Immediate annuities: In exchange for a lump sum payment (or premium), an insurance company promises to immediately begin making regular income payments to you for a chosen length of time (usually five years to life). The amount of your payment will vary based on your age, gender and the length of the term selected. When you annuitize, you are giving up the principal and only have rights to the future income.
Fixed annuities: These are a lot like a certificate of deposit (CD) in that you give an insurance company a lump sum of money, and they offer you a fixed rate of return over the agreed-upon time period. Like a CD, if you need to make an early withdrawal during that time, there could be a penalty.
Variable annuities: These are often described as mutual funds wrapped in an annuity contract and purchased through an insurance company. The investment options are referred to as “subaccounts,” and just as when you invest in your 401(k) or brokerage account, you can choose to be aggressive, moderate or conservative. Your account value benefits from the upside of the markets, but it also is vulnerable to market losses.
Fixed index annuities or equity index annuities: These “hybrid” annuities act almost as a combination of fixed and variable annuities. They have the principal protection of a fixed annuity but also some upside potential because of their ability to earn interest based on the performance of the index to which they’re linked, such as the S&P 500.
Obviously, these are very brief descriptions. If you are truly interested in evaluating what an annuity could do for you, you’ll benefit from some research into specific products and an in-depth conversation with a financial professional before making a purchase.
3 Tips When Considering Annuities
Here are three things to keep in mind as you move forward:
- Know the costs. Annuities have all sorts of customization options or “riders” that can be attached to a contract to expand or restrict a policy’s benefits. These can guarantee a lifetime income without having to annuitize, add long-term care features, enhance the death benefit and much more. These options almost always come at a price — and that’s on top of the base contract costs. They can add up, especially for a variable annuity, which typically has subaccount fees, administrative costs and mortality costs built into the base policy.
- Understand the timeline. It’s never wise to put funds for shorter-term needs into an annuity. Make sure you maintain adequate liquidity to deal with daily and unexpected expenses, as annuities typically charge hefty penalties for violating early withdrawal terms. Also, be aware of the liquidity provisions, as some annuities offer one free annual withdrawal, allowing you to take out a specified amount that isn’t subject to penalties.
- Understand the risk and growth potential. You can’t expect to match market growth using fixed or fixed index annuities, and you can’t expect protection from market losses from a variable annuity. While a variable annuity can match market returns, fixed or fixed index annuities act more like a bond component of a retirement plan.
When you’re ready to speak to a professional about purchasing an annuity, it’s important to find an experienced, unbiased adviser licensed in both securities and insurance, preferably with a CERTIFIED FINANCIAL PLANNER™, Chartered Financial Consultant® or Chartered Life Underwriter® designation; who acts as a fiduciary; and who represents multiple insurance companies.
Annuities aren’t evil — they’re just another tool that may or may not fit within your financial plan. Because they’re complex, it’s easy to make mistakes. Proceed with caution and be sure you’re getting the best advice from someone you can trust.
Kim Franke-Folstad contributed to this article.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Richard W. Paul is the president of Richard W. Paul & Associates, LLC (opens in new tab), and the author of "The Baby Boomers' Retirement Survival Guide: How to Navigate Through the Turbulent Times Ahead." He holds life and health insurance licenses in Michigan and Florida and is a Certified Financial Planner, Registered Financial Consultant, Investment Adviser Representative and insurance professional.
Stock Market Today: Tech, Bank Stocks Lead Markets Higher
Retailers were big gainers, too, thanks to strong earnings from Lululemon Athletica.
By Karee Venema • Published
IRS: Don't Trust All Social Media Tax Advice
The IRS warns that not all social media tax advice should be trusted.
By Kelley R. Taylor • Published
How to Protect Your Cash and Investments in a Banking Crisis
A focus on FDIC insurance and Treasury-only money market or bond fund options can help safeguard investments when a banking crisis threatens.
By Peter Newman, CFA • Published
Maximize Charitable Giving Tax Savings and Give All Year
Thinking of December as ‘contribution season,’ paired with using tax-savvy giving tools, can help you spread the generosity all year long.
By Mark Froehlich, CPA, MBA • Published
Protect Your Retirement: Seven Things You Can Do Right Now
Whether you’re preparing to retire or already retired, a proactive plan is critical to help safeguard your retirement, especially amid uncertainty.
By Jessica Cervinka, IAR • Published
Buffer ETFs Can Limit Investing Losses in Uncertain Times
Doing your own risk-reward investing analysis might be easier said than done, especially when markets are volatile. That’s where buffer ETFs can come in handy.
By Kirk Tushaus • Published
Three Ways Technology Will Fix What's Broken in Philanthropy
Charities stand to benefit from evolving fintech and artificial intelligence that will make charitable giving more efficient, transparent, relevant, collaborative and impact-focused.
By Stephen Kump • Published
Four Steps for Teens Who Want to Test the Investing Waters
Teens who feel ready to try their hand at investing should first get educated, with adult supervision, and then it’s all about diversify, diversify, diversify.
By Kerim Derhalli • Published
Is Retirement in 2023 Still Possible?
Yes, it is, if you have a customized plan specific to your retirement. If you do, you’re in the minority, though, so here are some ways to develop that plan.
By Nicholas J. Toman, CFP® • Published
Being Rich vs. Being Wealthy: What’s the Difference?
It’s all about where you put the zeros — having a large bank account isn’t the same as having zero regrets and focusing on what brings you joy.
By Andrew Rosen, CFP®, CEP • Published