The Pros and Cons of Buying an Annuity

If the word “annuity” makes you hesitate, you’re not alone. Annuities aren’t as well-known as other financial tools like 401(k)s or CDs, but don’t discount them. While there are advantages and disadvantages, there is a reason that annuities have been a financial tool people have been using for centuries. Let’s dive into the pros and cons. 

How Annuities Work

In its most basic form, an annuity can provide regular income in retirement like a pension:

1. You purchase and fund an annuity. This is called the accumulation phase.
2. That money is invested by the company you purchased from. During this time – called the surrender period – you would need to pay a surrender charge or fee to pull those funds from where they are invested. This is because the annuity contracts are built based on having the money invested for a specific length of time.
3. During the annuitization period, you receive payments. This could be for a set period of time, until you receive a set amount of money or for the rest of your life.

There are three main types of annuities: 

Fixed annuities provide you with a pre-determined interest rate, providing a low-risk way to grow your investments and a clear picture of where you’re going.

Variable annuities provide some benefits of investments accounts, tying future payments to market performance. They are higher risk, including the potential to lose principal, but provide more opportunity for growth.

Indexed annuities are a blend of fixed and variable annuities. The interest rate you receive is based on the performance of a specific market index, giving you greater opportunity for growth than a fixed annuity, but provides more protection against loss than variable annuities. 

Benefits of Annuities

There’s a reason annuities are growing in popularity. Annuities can play a unique role in your financial plan because they offer advantages that can benefit your future. 

1. Regular Income

One of the primary reasons people purchase annuities is to provide stable, steady retirement income. In essence, an annuity can give you regular payments that provide peace of mind about your living expenses in retirement. Many can be structured to provide lifetime income so you never have to worry about outliving your savings.  

1. Tax-Deferred Growth

Regardless of whether you purchase an annuity with pre-tax money (qualified annuities), such as when you roll over a 401(k), or with taxed money (nonqualified annuities), such as with a large sum you’ve saved or inherited, you won’t pay taxes on the growth your  annuity accumulates until you begin to take withdrawals. Because that money continues to work for you, you have additional opportunities for growth.

3. Guaranteed Rate of Return

Fixed annuities and some indexed annuities offer a guaranteed rate of return. When you begin your annuity contract, you’ll know exactly how much that money will grow year-to-year and what that annuity will look like at the end of the accumulation phase. That assurance is a comfort for people, especially those who are looking for a way to add a lower-risk investment to their portfolio or who are approaching retirement.

4. Customizable Benefits

Some annuities offer additional benefits or riders that can help you meet your financial goals. These may be automatically included or be available as an optional add-on. Riders or customizable options can enable you to change how an annuity accumulates or pays out so that it works for you and your loved ones. For example, some annuity contracts allow a spouse to continue to receive payments after an annuity holder’s death.  

Drawbacks of Annuities

There’s no such thing as perfect; there are some disadvantages to annuities that you should be aware of if you are considering purchasing one.

1. Fees and Commissions

An annuity is a financial contract, which means there is a cost that the person purchasing the annuity pays to the issuing company to facilitate the annuity. This may be in the form of a one-time commission or regular fees that can impact your returns. 

1. Complexity

When comparing an annuity to another retirement savings vehicle – such as a 401(k) or IRA – they can seem a bit complicated. Unlike a workplace plan, you can’t just add money to an annuity every month; they may have a specific premium schedule that limits when you can make deposits or have a more complicated investment timetable than other accounts. Annuities are based on a contract and require potential buyers to carefully review the language to ensure the terms are understood. 

3. Penalties for Cashing Out or Cancelling

Annuities are meant to be a vehicle to save for retirement, so accessing your money before the end of the surrender period is discouraged. To help incentivize the long-term approach, many annuities include financial penalties, such as fees, for early withdrawals. 

Is an Annuity Right For You?

Because annuities offer such a range of options and can serve many different purposes, many people find they can benefit from one. However, determining which annuity fits your needs and situation can be complicated. Let a Farm Bureau agent help!