Are Annuities Good Investments? Weighing the Pros and Cons

Love ’em or loathe ’em, annuities can be a smart investment tool for the right person under the right circumstances.

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Some people may love annuities.

Some people may loathe them.

Of course, in many instances, a person’s views on annuities often come down to not just personal preferences, but also to whether they make money from them. A financial professional who sells annuities but has nothing else to offer prospective clients will likely point you in the direction of annuities. Likewise, someone who is not licensed to sell annuities will steer you away from them, quick to jump on any real or perceived faults in this investment option.

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Neither extreme is correct.

Annuities can be a smart investment – for the right person under the right circumstances. They are neither a financial cure-all nor an investment that should be viewed as taboo.

If you were to think of all the potential investments out there as tools crammed into one big toolbox, then annuities are just one of those tools. With an actual toolbox, if you need to drive a nail into a board, then you reach for the hammer, not the screwdriver, because you need the right tool for the job at hand.  

Annuities are the same way. They’re a tool to consider reaching for when the situation calls for it. One advantage of annuities, for example, is that they can be set up to provide you with a lifetime source of income. Some even have options to include your spouse. That’s something important to consider for anyone worried about running out of money in retirement.

For all the good they can do, annuities do draw plenty of criticism – some perhaps deserved, some not so much. Let’s explore a few things that are said about annuities and set the record straight.

Fees

One criticism of annuities is that they come with high fees. (A particularly strident critic describes them as “nose-bleed-level fees.”) This is disingenuous, though, because there are different types of annuities, and just how high the fees are varies.

Fixed annuities, for example, can have no fees at all. They work similar to a certificate of deposit (CD): You invest your money at a fixed interest rate for a specific period of time, and your return is guaranteed. CDs are guaranteed by the Federal Deposit Insurance Corp. (FDIC) (opens in new tab), and annuities are backed by the financial strength and claims-payable ability of the issuing insurance carrier. Fixed-indexed annuities can have fees and sometimes have little to no fees.

To be fair to the critics, one annuity where high fees are common is the variable annuity. But even when annuities have fees, a case can be made that people get value for the fees they pay, especially when there is an income rider that provides a lifetime stream of income. And even more so if that lifetime stream of income includes a cost-of-living adjustment and some additional benefits that can kick in to help offset costs of long-term care.

Taxes

Another concern some investors have about annuities is that they create tax issues. Yes, that monthly income stream the annuity provides can be taxable, but people typically buy an annuity with their retirement savings. Those savings are usually in traditional IRAs or 401(k)s, which are taxed anyway when withdrawals occur.

There is no difference between the tax rate on the annuity and the tax rate on the IRA or 401(k) withdrawal. So, yes, there can be taxable income when the funds are distributed, but they are essentially the same issues many taxpayers would face anyway.

Lack of Liquidity

If you own a stock and you want to rid yourself of that stock, you can easily sell it and have your cash within a few days. The speed with which you can turn an investment into cash is called liquidity, and one criticism of annuities is that they aren’t very liquid. That is because they are designed to be long-term investments for retirement income.

Once you’ve invested in one, the critics say, you are stuck. This is sort of correct. It is possible to withdraw a certain amount of your money from an annuity each year with no penalty, but there are surrender fees designed to discourage you from withdrawing the entire amount. Paying those surrender fees could be financially painful.

But here’s my thought on the liquidity issue: If you have an annuity with a lifetime benefit, why would you want to cash it in? I can’t think of a reason.

Lengthy and Complex Contracts

Yes, it’s true that – as some critics gleefully point out – annuity contracts are decent-sized documents. But while that might be frustrating when you have to read through page after page of legal language before signing, it’s not a bad thing. After all, you want the contract to be detailed to make sure those lifetime guarantees you have coming to you are in writing. A few paragraphs aren’t going to accomplish that.

Also, the contracts are not as complicated as some people make them out to be (I mean, come on, have you seen the size of some prospectuses?), so don’t let yourself become overwhelmed or misled. You can always seek advice if you encounter anything that confuses you.

Adviser Commissions

Finally, those who find fault with annuities also sometimes claim that annuities are good only for the adviser who sells them because that person receives a commission.

As I mentioned before, this might be a legitimate issue to grumble about if the financial professional is licensed to sell annuities and nothing else. But you can also look for a financial professional who has a more diverse financial toolbox. That person can ask questions, come to understand your needs and create a financial plan that meets those needs.

Ronnie Blair contributed to this article.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Investment advisory products and services made available through AE Wealth Management, LLC (AEWM), a Registered Investment Advisor.

Insurance products are offered through the insurance business Miller Retirement Group. Miller Retirement Group is also an Investment Advisory practice that offers products and services through AE Wealth Management, LLC (AEWM), a Registered Investment Advisor. AEWM does not offer insurance products. The insurance products offered by Miller Retirement Group are not subject to investment Advisor requirements. AEWM and Miller Retirement Group are not affiliated companies. 1597118 - 12/22

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 (opens in new tab) or with FINRA (opens in new tab).

Nate Miller, Investment Adviser Representative
President, Miller Retirement Group

Nate Miller is president of Miller Retirement Group (opens in new tab). Miller has more than two decades of experience in the financial industry and holds insurance licenses in Kansas and Missouri. He also has passed the Series 65 exam and is registered as an Investment Adviser Representative in those same states. Miller also is the author of "The CPR Retirement Rescue Roadmap: Your Guide to Breathing Life Into Any Portfolio."