Pros and Cons of Annuities

PROS

• Investment earnings grow tax-free. That means your money can grow and compound faster than money in a taxable account earning the same before-tax rate. The higher your tax bracket and the longer you defer, the bigger your advantage. While you’ll eventually have to pay taxes on your earnings, you’re likely to do so at a lower income tax rate in retirement. You’ll also have the option to control your withdrawals so that more is taken during years of lower tax obligation, and vice versa.
• Alternative to other tax-favored investments. If you’ve exhausted other forms of tax-favored retirement savings, like 401(k)s and IRAs, annuities offer yet another tax-advantaged investment option. As your earnings compound over time, you’ll have growth potential that’s unmatched by taxable accounts.
• Unlimited contributions. Deferred Annuities have no IRS contribution limits, so you can invest as much as you want for retirement. This helps you catch up on retirement savings when you have less time to save.
• No required minimum distributions (RMDs). Unlike qualified retirement plans requiring you to withdraw from your account by age 70½, certain annuities may not have RMDs. You can continue to defer taxes as long as you’d like.
  
• Competitive interest rates. The rate paid by Fixed Annuities is based on yields generated from your insurance company’s own investment portfolio, which tends to be higher than similar investment vehicles such as money market accounts or CDs.
  
• Minimum rate guarantees. Your initial interest rate guarantee will expire, after which your rate will be adjusted to current market rates. Current market rates could be higher or lower, but never lower than the minimum rate stated in your contract.
  
• Safety of principal. With Fixed Annuities, your principal balance is backed by your life insurance company’s assets. States impose stringent reserve requirements, and the highest-rated life insurers are generally recognized to be the safest of all the financial institutions. Moreover, most states have a guaranty fund to cover any annuity losses.
  
• Access to funds. You can withdraw up to 10 percent of your account balance annually before accruing any charges. After the surrender period, which lasts as long as 12 to 15 years, you’ll have access to 100 percent of your money.
  
• Reduced tax impact on your Social Security benefit. If your total income from all sources surpasses a specific threshold ($34,000 for individual filers and $44,000 for joint filers), up to 85 percent of your benefits may be taxable. Annuity income is exempt from this calculation.
  
• Asset protection. Annuities are one of the few investments with almost complete protection from creditors and lawsuits. The provisions vary by state.
• Probate protection. By designating a beneficiary in an annuity contract, owners protect heirs from probate. Your annuity proceeds are protected from the delays and expenses associated with the probate process.
• Death benefits. If you pass away before your distribution period begins, your beneficiary receives at least the amount that you put in. Many annuities also offer an “enhanced” death benefit.

CONS

• Illiquidity. Deposits into annuities are generally locked up throughout the duration of the surrender period, which usually lasts from two years to 10 or more. Consider your financial requirements during the duration of the surrender period, and ask your Fiduciary Advisor whether you have sufficient liquid assets elsewhere in your portfolio prior to purchasing an annuity.

• Surrender fees. You must pay fees on withdrawals exceeding 10 percent of either original premium deposit or 10 percent of your account value. Surrender fees start out at around 7 to 15 percent and decline by a percentage point each year until they vanish at the end of the surrender period.

• Early withdrawal penalties. For the privilege of deferring taxes on earnings inside an annuity, you will owe a tax penalty on any withdrawals made prior to age 59½.

• Fees and expenses. Annuities are a controversial topic in retirement planning, partly because they’re more expensive to buy and maintain. However, it is possible to find lower-cost annuities with reduced surrender fees and low commissions.
• Interest rate risk. Anytime you invest in a fixed-rate investment vehicle, your funds are exposed to interest rate risk. Depending on the length of your guarantee, you risk receiving a lower rate or missing out on higher rates in future years.

• Credit risk. Though there is always the risk that an insurer does become insolvent, insurance companies are much better capitalized than banks. Moreover, annuity owners are protected by their state guaranty fund. You can reduce credit risk by selecting the most highly-rated life insurers (A+ from Best, AAA from Moody’s or Standard & Poor’s).

• Inflation risk. Most “safe” investments can expose your funds to inflation risk. That shouldn’t be a concern if a portion of your investment portfolio is invested in equities, which are a proven hedge against inflation.