You’re at a dinner party, and someone mentions annuities. Suddenly, the room goes quiet, and people start shifting uncomfortably in their seats. It’s as if someone just admitted to liking pineapple on pepperoni pizza (which, by the way, is delicious).
I get it. It’s a term that has gained a bit of a bad reputation over the years, often associated with high fees, pushy sales tactics, and confusing contracts. But is this reputation entirely fair? Not really. In some cases, annuities could be just what you need in your financial portfolio.
What Exactly Is an Annuity?
At its core, an annuity is simply an investment product offered by an insurance company. The basic premise is that you give the insurance company a lump sum of money, and in return, they promise to provide you with regular payments immediately or at some point in the future. The idea is to create a stream of income, often for retirement, that you can count on—much like a pension.
However, annuities come in many different forms, each with its own set of rules, benefits, and risks. This variety is both a blessing and a curse. It means there’s likely an annuity out there that could be an excellent fit for your financial plan, but it also means there’s a lot to learn before you can make an informed decision.
The Checkered Past of Annuities
So why do annuities have such a bad rap? Annuities have been available in the United States for over two centuries. Historically, annuities were known for their high commissions, which led some financial advisors and insurance agents to over-recommend them to clients who didn’t necessarily need them. This created a lot of mistrust and skepticism, as people began to see annuities as a product that benefited the seller more than the buyer.
But the financial world has changed. The cost of insurance products, including annuities, has decreased across the board, making them more accessible and fairer for consumers. Additionally, with the decline of traditional pensions, annuities have become a valuable tool for creating a reliable income stream in retirement—a need that’s more important now than ever.
The Life Insurance Marketing and Research Association (LIMRA) reports that annuity sales in the United States were up over 21% for the first quarter of 2024. Brian Hodgens, head of LIMRA research, expects annuity sales to “continue to perform well.”
Annuity Pros and Cons: What you Need to Know
Let’s break down some of the pros and cons of annuities to give you a clearer picture of what they can offer:
Pros:
- Guaranteed Income: Annuities can provide a steady, predictable income stream, which can be particularly reassuring in retirement, especially if you are worried about outliving your savings.
- Protection Against Market Volatility: Some annuities offer protection against market downturns, which can be a significant benefit if you’re concerned about running out of money during retirement.
- Tax-Deferred Growth: Money invested in an annuity grows tax-deferred, meaning you will only pay taxes on the earnings once you start receiving payments.
Cons:
- Complexity: Annuities can be complicated, with various terms and conditions that can be hard to understand.
- Fees and Surrender Charges: Some annuities have high fees or penalties if you need to withdraw your money early.
- Limited Liquidity: Depending on the annuity you’ve invested in, there may be limitations on withdrawals.
RILA Annuities: A Newer Option Worth Considering
One of the newer types of annuities gaining popularity is the Registered Index-Linked Annuity (RILA). RILA annuities allow you to participate in the stock market’s growth while offering some downside protection. This means you can potentially earn higher returns than a traditional fixed annuity but with less risk than investing directly in the market.
For example, let’s say the stock market does well one year. With a RILA, you’d benefit from that growth, but if the market takes a dive the following year, your losses would be limited to a predefined amount. This balance of risk and reward can appeal to those looking to grow their money without exposing themselves to too much market volatility.
Fixed Annuities: The Safe Bet
If the idea of market risk makes you nervous, a fixed annuity might be more your speed. Fixed annuities offer a guaranteed interest rate for a specified period, similar to a certificate of deposit (CD). The key difference is that a fixed annuity is offered by an insurance company rather than a bank, and the interest rates tend to be higher than those offered by CDs.
Fixed annuities can be a good option for those who want a low-risk investment with a steady return. However, it’s important to note that, like all annuities, fixed annuities are long-term investments, and there may be penalties for withdrawing your money early.
Annuities Aren’t One-Size-Fits-All
It is essential to understand that while annuities can be a great addition to your financial plan, they’re not for everyone. Annuities should be seen as just one piece of your overall investment strategy and should make up, at most, 20-25% of your overall investments or income sources.
Just like any financial product, the key is to be an educated consumer. Don’t just take an advisor’s word for it—make sure you’re looking under the hood of any annuity you’re considering. Understand the fees, the terms, and the potential benefits before you make a decision. And remember, the best financial decisions are the ones that are tailored to your specific needs and goals.
The Final Verdict: Are Annuities Really That Bad?
The short answer is no—annuities aren’t inherently bad. Like any financial product, they have pros and cons, and whether or not they’re a good fit for you depends on your situation.
For many people, especially those concerned about having a reliable income in retirement, an annuity can be a valuable tool. The key is to work with a trusted financial advisor who can help you navigate the complexities of annuity investments and ensure you’re making the best decision for your future.
Remember, the financial landscape is constantly evolving, and so are the products available to you. Annuities have come a long way, and the right one might be just what you need to secure a comfortable and enjoyable retirement.
At Legacy Planning, we’re passionate about helping you navigate the complex world of retirement planning, including annuities and other financial tools. Schedule a conversation to see if we can help you create a secure and enjoyable retirement strategy tailored to your unique needs. Let’s work together to turn your financial goals into reality.
And the next time someone brings up annuities at a dinner party, instead of reaching for another glass of wine to drown out the conversation, maybe lean in and share your newfound knowledge. Who knows? You may become the financial guru of your social circle.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Guarantees are based on the claims paying ability of the issuer. Withdrawals made prior to age 59½ are subject to a 10 percent IRS penalty tax and surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns and principal value of the available subaccount portfolios will fluctuate, so the value of an investor’s unit, when redeemed, may be worth more or less than the original value. Optional features available may involve additional fees.
