Some people may love annuities.
Some people may hate them.
Of course, in many cases a person’s views on annuities often come down to not only personal preference, but whether they make money from them. A financial professional who sells annuities but has nothing else to offer potential clients is likely to refer you to annuities. Likewise, someone who is not licensed to sell annuities will steer you away from them, quickly jumping on any real or perceived flaws in that investment option.
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Neither extreme is correct.
Annuities can be a smart investment – for the right person in the right circumstances. They are neither a financial medicine nor an investment to be considered taboo.
If you have to think of all potential investments as tools crammed into one big toolbox, then annuities are just one of those tools. With a real toolbox, if you need to drive a nail into a board, then you reach for the hammer, not the screwdriver, because you need the right tool for the job.
Annuities are the same way. They are a tool to turn to when the situation calls for it. One advantage of annuities, for example, is that they can be set up to provide you with a lifetime source of income. Some even have options to include your spouse. This is an important thing to keep in mind for anyone worried about running out of money after retirement.
For all the good they can do, annuities draw a lot of criticism—some perhaps deserved, some not so much. Let’s explore a few things that are being said about annuities and set the record straight.
Taxis
One criticism of annuities is that they come with high fees. (A particularly vitriolic critic described them as “nosebleed-level fees.”) This is disingenuous, however, because there are different types of annuities and how high the fees vary.
Fixed annuities, for example, may have no fees. They work similar to a certificate of deposit (CD): You invest your money at a fixed interest rate for a set period of time, and your return is guaranteed. CDs are guaranteed by the Federal Deposit Insurance Corporation (FDIC) (opens in new tab), and annuities are backed by the financial strength and claims-paying ability of the issuing insurance carrier. Fixed indexed annuities can have fees and sometimes have little or no fees.
To be fair to the critics, one annuity where high fees are common is the variable annuity. But even when annuities have fees, a case can be made that people are getting value for the fees they pay, especially when there is an income rider that provides a lifetime income stream. And even more so if that lifetime income stream includes a cost-of-living adjustment and some additional benefits that can help offset long-term care costs.
Taxes
Another concern some investors have about annuities is that they create tax problems. Yes, that monthly income stream that an annuity provides can be taxable, but people usually buy an annuity with their retirement savings. These savings are usually in traditional IRAs or 401(k)s, which are taxed anyway when withdrawals occur.
There is no difference between the tax rate on an annuity and the tax rate on an IRA or 401(k) withdrawal. So yes, there may be taxable income when the funds are distributed, but essentially these are the same issues that many taxpayers would face anyway.
Lack of liquidity
If you own stocks and want to get rid of them, you can easily sell them and get your money within a few days. The speed at which you can turn an investment into cash is called liquidity, and one criticism of annuities is that they are not very liquid. This is because they are meant to be long-term investments for income after retirement.
Once you’ve invested in one, critics say, you’re stuck. This is somewhat correct. It is possible to withdraw a certain amount of your money from an annuity each year without penalty, but there are withdrawal fees designed to discourage you from withdrawing the full amount. Paying these transfer fees can be financially painful.
But here’s my take on the liquidity issue: If you have an annuity with a lifetime benefit, why would you want to cash it out? I can’t think of a reason.
Long and complicated contracts
Yes, it’s true that – as some critics gleefully point out – annuity contracts are decent-sized documents. But while it can be frustrating when you have to read page after page of legalese before you sign, it’s not a bad thing. After all, you want the contract to be detailed to make sure those lifetime guarantees you’re getting are in writing. A few paragraphs won’t accomplish that.
Also, contracts aren’t as complicated as some people make them out to be (I mean, come on, have you seen the size of some prospectuses?), so don’t be overwhelmed or misled. You can always seek advice if you encounter something that confuses you.
Advisor Fees
Finally, those who find fault with annuities also sometimes argue that annuities are only good for the advisor selling them because that person gets a commission.
As I mentioned before, this might be a legitimate issue to grumble about if the financial professional is licensed to sell annuities and nothing else. But you can also look for a financial professional who has more diverse financial tools. This person can ask questions, understand your needs, and create a financial plan that meets those needs.
Ronnie Blair contributed to this article.
Appearances in Kiplinger were obtained through a PR program. The columnist was assisted by a public relations firm in preparing this material for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Investment advisory products and services provided through AE Wealth Management, LLC (AEWM), a registered investment advisor.
Insurance products are offered through the Miller Retirement Group insurance business. Miller Retirement Group is also an investment advisory practice that offers products and services through AE Wealth Management, LLC (AEWM), a registered investment advisor. AEWM does not offer insurance products. Insurance products offered by Miller Retirement Group are not subject to investment adviser requirements. AEWM and Miller Retirement Group are not affiliated companies. 1597118 – 22/12
This article was written by and represents the views of our advisor and not the Kiplinger editorial team. You can check the advisors’ SEC records (opens in new tab) or with FINRA (opens in new tab).