Annuities can be very confusing, most people don’t even know what they are, but for the right investor annuities can be a very valuable part of their retirement portfolio too. The one thing I’ve noticed is that the web doesn’t have have many reliable resources to tell what the annuities pros and cons are. Don’t worry, Annuities Explained is here to help. Lets take a look at the pros of annuities.
Tax Advantages of Annuities
Annuities have a very good tax advantage for most investors. When you buy an annuity your money is invested tax deferred until you begin withdrawing your funds. Once you start receiving annuity payments only the portion of your investment that was gained is actually taxable, and quite often when you retire you are sitting at a lower tax bracket than you were during your working life. There is also an advantage to deferring tax with the time value of money which in short states that money paid out today is worth more than money paid out in the future.
Guaranteed Rate Of Return
Typically fixed annuities offer a guaranteed rate of return. The amount of that return depends on the agreement with the issuer, but since it is guaranteed it is usually lower than stock market investments or mutual funds, but the allure of a guaranteed investment return is one that is desirable for many investors, especially when planning retirement investments. Variable annuities also typically offer a guaranteed rate of return as a floor, but mixes in some investments based on stocks, index funds or mutual funds so you have an opportunity to improve that return, but have the guaranteed rate of return to fall back on should the investment portion of your annuities not fare so well.
No Maximum Investment For Annuities
Unlike 401k and IRA accounts, there is no maximum investment amount for annuities. So what that means is if you are looking to invest as much money as possible in a tax deferred investment then annuities might be right for you.
Disadvantages of Annuities
While I really feel that annuities are a good investment, especially for the risk averse, there are a few disadvantages of annuities that may prevent the typical investor from sinking their money in to a fixed or variable annuity. Let’s take a look.
Annuities Are Not Very Liquid
For investors who have money to stick away that they know they will never need annuities make sense, but if you think that you may need your investment income for some other purpose then you may want to stay away from annuities. Most annuities have a penalty percentage if you withdraw your funds early and this penalty can be as high as 10% in the first year (the rate usually declines after a few years). You can sell your annuities on the secondary market, but there may be transfer fees involved so be sure to read any fees paperwork carefully.
Annuity Fees Can Be High
In addition to the early withdrawal penalty, the regular annuity fees tied to annuities can be higher than normal retirement investments. Since annuities are often offered by insurance companies, they don’t have the economies of scale that investment companies have so in order to make up for this they have to charge their customers more. Often times fees can really eat away at your annuity yield adding up to 2-3% or more with some annuities.
Bottom line, annuities have their pros and cons and it really depends on what type of investor you are. For the typical investor it is recommended that you max out your IRA and 401K plans before considering an annuity, unless of course you have a large amount of money to invest, then an immediate annuity is what you need. Regardless be sure you read and understand all pros and cons of annuities before investing.