Deciding whether to invest in an annuity can be a stressful financial decision. Fixed annuities can be a good investment for people wanting to secure wealth, but there may be better financial options available. It’s important to consider all of the factors at hand, whether that be looking at your personal finance or consulting companies on their fixed annuity rates.
We’ll help you decide whether annuities are the right investment for you.
What Is an Annuity?
Annuities are contracts issued by insurance companies. They can be purchased through monthly payments or, more infrequently, through lump sum bills. Their main purpose is to pay out a guaranteed income regardless of other factors over an agreed period of time, often throughout a person’s lifetime.
Put simply, you’ll pay now for a steady income stream in the future.
You can either pay for your annuity upfront or through regular payments, both of which may be subject to fees.
Annuities are quite popular, given that they offer the buyer a guaranteed income during retirement. A fixed annuity sets a rate of return for the investor that cannot fluctuate. The focal point for a fixed annuity is often a market index or index fund.
On the other hand, a variable annuity, while working on the same principle, can fluctuate depending on how the market behaves. An upturn in the market means more value in the investments of the annuity, while a downturn diminishes the value of the annuity.
As such, variable annuities are riskier, although they often put the investor in control of how to invest the money.
Pros and Cons of Annuities
Annuities can be a worthwhile investment for some but will require some research and consideration before you decide whether to buy.
Pros of Annuities
The main appeal of an annuity is that it offers the investor a stable income during their retirement. Even if the market takes a sudden turn for the worse, your insurance company is still obligated to pay you according to the terms of your contract.
As far as investing goes, this feature makes annuities (especially fixed annuities) one of the most secure investments you can make.
Annuities often come with the capability to customize your annuity plan as well, such as establishing minimum income benefits or spousal provisions to ensure that your spouse still receives the benefits of the annuity if you pass away.
An annuity can be invaluable if you acquire a large amount of money for any reason. Securing that wealth in an annuity has two positive effects.
- It can stop you from overspending in the short term and leaving nothing for your retirement.
- It protects your investment from a market downturn, which could significantly depreciate the value of your wealth.
The Cons of Annuities
Annuities often receive a lot of criticism, and for good reason. First and foremost, annuities will never net you a large profit compared to other investments. There are simply better ways to manage your money if your goal is to actively grow wealth through investment.
As the returns on annuities are often subpar, the associated fees can chip away at your guaranteed income over time.
While they may be useful to protect money from economic crises, it’s almost always better to put money into an IRA or 401(k) first since these investments have better returns and don’t eat away at your hard-earned money with as many fees.
Fees
Speaking of fees, annuities always carry more fees than other investments, making the already subpar returns on an annuity diminish even more. Maintenance charges and operational fees are bad enough, but when they cut into your retirement income, it can be quite upsetting.
Another important note for investing in an annuity (or any retirement investment for that matter) is that you should never withdraw money from it before a certain time has elapsed.
If you do, you’ll be subject to additional surrender charges and sometimes even a 10% early withdrawal penalty.
When Is an Annuity Right for You?
With so many negative attributes, an annuity should rarely be your go-to retirement safety net—the benefits from an IRA or 401(k) are just that much more forgiving.
The only time an annuity has merit is if you have a significant chunk of money that you want to protect from inflation, although even then, there are better options, and, in some cases, even an annuity isn’t safe from an economic downturn.
For example, if the insurance company isn’t able to stay afloat in an economic crisis, which is when the annuity is supposed to be most beneficial in protecting your wealth, they may go out of business, leaving you with nothing in return for your investment.
As such, like any investment you may choose to make, annuities do still come with a degree of risk, and you should always ensure that your insurance company is reputable and stable before investing in an annuity.
Why Are Annuities So Popular?
With so many downsides, you might be wondering why annuities are pushed so often in financial circles, and the reason likely comes down to the bottom line.
Financial advisors and brokers usually have the highest commission rates among financial occupations, making it quite lucrative for them to push annuities as the best financial option for their clients.
As such, if you’re considering your retirement investment options, it’s always worth doing some research and checking with a financial advisor you can trust before you sign on the dotted line.
The Bottom Line
At the end of the day, annuities are a type of investment that is situational. Just like anywhere you choose to put your money, it comes with a degree of risk.
Operating on a “pay now, earn later” basis, an annuity guarantees income over a fixed period of time, sometimes regardless of economic conditions. This can ensure a more comfortable and reliable retirement if that is the intended use for the annuity.
Unfortunately, annuities aren’t always the best investment and are often better suited as a secondary backup for your IRA or 401(k) since they don’t offer solid returns and charge more fees than other investments.