The Pros and Cons of Annuities

Here's a list of the pros and cons of annuities. It begins with the pros:

1. Flexibility and investment choices
2. Tax deferral for your investment gains
3. Income for life
4. Asset protection
5. Potential protection from market losses.

And now the cons:

1. Irreversible consequences.
2. Locked up until 59 ½.
3. Poor tax planning.
4. Insurance company financial health.
5. Inability to screen for your moral and social preferences.
6. Surrender charges
7. Up-front commissions.
8. Annual fees, administrative charges, mortality expenses, and other charges

The article then gets to the heart of why annuities are often a bad deal for investors:

With so many layers of fees, how will you make money? I have seen investors who have been in annuities for 10 years or more make very little money because of these high fees. It will affect your investment performance. These charges are often buried into the cost of your annuity. Reading a prospectus is often eye-opening!

Of course, new products are always coming on the market and low-cost companies are starting to come out with their own annuity products, so as costs drop, those objections may go away (or will at least be minimized.) That said, you'll still need to weight the pros and cons carefully since locking into an annuity is often a decision that's difficult, if not impossible, to un-do.

Personally, I haven't thought a lot about annuities since I don't have the need for extra income at this point in my life. In addition, I'm guessing that rates of return are pretty low these days. Will I ever consider annuities? Sure, but not until retirement (or close to it.)

Has anyone out there invested in annuities? Why or why not?

By the way, if you want to know more on this subject, check out these posts:

• Why Annuities Are a Bad Idea 
• The Psychology of Why People (Used to) Hate Annuities 
• All About Annuities

Comments

[TL]

I used to work at a large insurance company helping it's agents with suitability of insurance and annuity products.

I no longer work there. In my opinion, annuities should only play a role at or in the retirement phase to provide guaranteed income (immediate annuity), and only then should be part of a total plan and not the only solution. The fees draggin on the performance of the deferred annuities outweighs any benefits they have. The way they are structured, I kind of thought of them as a gambling game at a casino. Who do you think the odds are in favor. You the individual, or the mega billion dollar insurance firm with a whole staff of acutuaries.

TL

[jeffinwesternwa]

As a former Financial Advisor, Principal and RR of 16~ years, I sold MYSELF a VARIABLE ANNUITY for all my "deferred" (IRA) monies when I retired @ age 47~. The deferred money was "about 25%" of my liquid net worth and will, like the VA withdrawal BE taxed as ordinary income anyway. I invested at about S&P 1525, about 2%~ off the record high (even the pros can't hit a market high!:), 1) my VA "locks in principal" with a 10 year, any annually thereafter, with a principal guarantee. 2) In addition, after 11 years I am guaranteed a 7% "withdrawal rate" of teh high balance point which equates now to about $48K a year (7% of high point balance-so far) ANNUALLY, that's FOREVER! 3) The principal and w/d amount in dollars CAN increase as the contract has ANNUAL step ups that lock in ANY market gains each year. 4) Also, it has 10% available annual withdrawals w/o canceling the contract, the ability to NEVER annuitize and MANY investment choices. Hint: go for maximum growth w/ VA's to offset the typical 2-3%~ fees since many have guarantees anyway. Mine allows a diverse portfolio of 75% equities and 25% fixed/other investments as the MOST aggressive. Look NOW at the policy: I have ALL my principal at just the 10 year point (6+ yers from now) "if" markets don't recover, I get a LIFETIME of income EVEN IF THE CONTRACT VALUE FALLS TO ZERO (some thought the markets would when down 50+% a year agao!). I cannot EVER LOSE income! My portfolio is well diversified w/in the contract. VA's get a bad name cause of poor sales jobs but, for the right person/couple, for up to 50% of your monies, with the right riders, VA's can be SUPERIOR to other investment options. I'm VERY glad I did for this portion of my portfolio! Also, many good fixed annuities have a place also but, are used differently than VARIABLE contracts. Sales of VA's as the insurance companies have added many nice riders have dramatically increased in last 5~ years, even with tougher sales regulation requirements. Just part of the proof they are effective for many folks...Addendum: The insurance co issuing this contract does not sell these features in one contract anymore as they felt is was "too good" for the consumer and placed too much actuarial risk on the co. Still many other co's sell great contracts! An open mind can help se the benefits, not for everybody but, for many...

[jim]

Personally I like the immediate annuity as an option at retirement to ensure a good monthly income for life. I don't like other uses for annuities like variable annuities as investment vehicle. With any annuity you do have to be pretty careful about fees and costs and shop around. I don't think an annuity is a good investment any more than I think cash value life insurance is a good investment. So again, personally I'd only consider an immediate annuity to ensure retirement income stream and for that I like them in some situations.

[Roy Nelson]

What happens if the insurance company goes out of business like AIG almost did? I was planning to use annuities for retirement income, but after this recession I think I will stick with FDIC insured for near term income.

[chynalemay]

The FDIC has a LOT less resources ($$) than a quality (Superior rated) insurance co, so I'd take MY chance with the latter vice the govt., however, having BOTH IS a diversifier! Check out some fixed deferred or immediate annuities for a portion of CD type invested money, or a Variable Annuity for deferred IRA and (later) needed income money w/ growth potential!

[Barry]

I manage my mother's retirement money. Looking at her budget a few years ago, I saw two things:
1) To cover her expenses, she needed about $400/month on top of Social Security.
2) That interest rates were high and (I felt) likely to decline. (Boy, was this a good call!)

So I invested just enough of her savings in a low-cost, fixed annuity to cover that amount and left the rest in traditional stocks and mutual funds. (We used about 20% of her investable assets to fund the annuity.) I think this was a good compromise between safety and growth potential. We may create another annuity later as inflation reduces the constant-dollar value of the first one.

[Strick]

Roy - there are state insurance pools to cover guaranteed monies in annuities (subject to limits), similar to the FDIC. So I wouldn't worry too much about it as long as long as you stay under these limits and make sure the product is one that is covered (unless maybe if you live in California).

I think Barry's example is a great case for annuities (fixed immediate for income). I would bet because of the comfort carried by having the necessities covered by the annuity and SS, the rest of the portfolio will be invested more aggressively than otherwise and (most likely) grow the overall portfolio more over time with much less fear.

[William Peiffer]

Fixed annuities have no fees, and are the perfect safe place to invest retirement savings. Fixed annuities have averaged 5.79% over the last 15 years. (Wharton School of Finance 2010 report “Real World Indexed Annuity Returns") In a worst case scenario you wake up with the same amount you had yesterday. You cannot lose money in a fixed annuity.
Many Fixed annuities offer a bonus on initial deposits. Yes there are surrender charges for the first 1o years. But most annuities allow for penalty free withdrawals of 10% each year. Using proper suitability a client should always have access to liquid money and not have all liquid assets in annuities. Look at it this way if you have money in the market and you need access to some of it, you are at the mercy of the market value at the time you need it. With an annuity you will always know the cost to access your money at any given time in the future. If you are in retirement or near retirement an annuity is the perfect safe place to stash money. It's safe, guaranteed and offers a fair return. Commissions are paid once, but not from the investors funds. Commissions are paid from the general account of the insurance company. Unlike equities that pay commissions every year from the investors funds, if the market is up or down. Fees and commissions on equities reduce your gains and increase your losses. And then there is the option for income for life. In the absence of a defined benefit plan and the growth of defined contribution plans, the lifetime income rider available on most fixed annuities is the perfect way to guarantee one will not outlive their savings.

[Lynne Kidd]

Has anyone ever invested in a fixed annuity with an income rider? I am 73 and my husband is 76. We have all of our money invested in the market except for an annuity that we will annuitize in Sept. We need safety and want to get out of risk. It is so hard to know who to believe.

[FMF]

Lynne --

This is an old post, so you'll likely not get any feedback. If you want to give some more details and send your questions to me as a "help a reader" question, you can. Details here:

http://www.freemoneyfinance.com/2010/02/how-to-submit-a-help-a-reader-question.html

[Andy]

Fixed annuities are really designed for individuals who desire safety and predictability. As long as the company is solvent then the annuity is safe. The annuity is protected by a legal reserve of assets that are required to be held by insurers to pay policy holders.