An annuity can accomplish one simple goal: income during retirement. However, the spectrum of annuities that are available – and the specifics of each contract—makes deciding whether or not an annuity is beneficial for each individual consumer a complex matter.
Understanding the general advantages and disadvantages of annuities can help financial advisors and consumers alike.
Pros Of Annuities
Three of the primary benefits of annuities are lifetime income, tax benefits and principal protection.
• Lifetime income, which is a guarantee with certain annuities, provides annuitants with payments that continue as long they are alive. The payments are often higher than Social Security and pensions, as there are not contribution limits.
• Annuities include multiple tax benefits. The main tax advantage is the ability to make contributions and not pay any taxes until you make withdrawals. Basically, the money has time to grow without penalties. You can also roll over funds from qualified IRAs or 401(k)s without tax penalties.
• Principal protection is a feature of fixed and equity-indexed annuities; it guarantees that the value of the annuity will not fall below the amount of money initially invested. While other investment options carry risks, this offers a nice guarantee.
Cons Of Annuities
Three hindrances to consider when considering annuities include limited return, inflexible commitment and fees.
• Limited return is often the downside of annuities that come with principal protection. Eliminating the risk limits the return. Stocks, bonds and mutual fund investments fluctuate, allowing a greater potential for growth than some annuities.
• The inflexible commitment that is a part of annuities may deter some consumers. Once the contract is signed and the money is invested, the consumer has limited access to the money. If an emergency or major expense arises, consumers would need to sell their annuity payments to a third party in order to access their money.
• The fees that accompany annuities are the biggest deterrent for many. Written into each contract are fees for added features and early withdrawals. For some annuities, the return may not be worth the amount paid in fees.
When It's Time To Decide
As consumers evaluate annuities, it is important to make sure that the contract is read in full and understood. Terms, fees and features differ greatly from annuity to annuity, so time should be spent making sure that the annuity will meet an individual’s needs.
Perhaps more important than this is gauging how an annuity fits into an investment portfolio. An annuity may be a prudent choice if there are savings in another account, some risk taken in stock holdings, and additional money available to buy an annuity.
Just as with other major financial commitments, it is vital to consider assets and needs, and how to leverage the time between now and the golden years to its fullest potential.
Alanna Ritchie is a writer for Annuity.org, where her primary focus is personal finance.