Disclosure: Our content does not constitute financial advice. Speak to your financial advisor. We may earn money from companies reviewed. Learn more
Akin to any investments, what works for some investors, may have drawbacks for other investors. Fixed annuities come with advantages, as well as disadvantages. In this article, 5 financial experts discuss the pros and cons of fixed annuities.
Table of Contents
- Guaranteed Fixed Returns And Tax-Deferred Growth, But Withdrawal Penalties And Lack Of Flexibility
- Dispelling Common Myths And Misinformation
- What Is Best For One Person May Not Be Best For Another
- Keep In Mind That Proper Diversification Of Your Overall Portfolio Is Important
- A Certain Level Of Guaranteed Income, But This May be Their Primary Disadvantage As Well
Guaranteed Fixed Returns And Tax-Deferred Growth, But Withdrawal Penalties And Lack Of Flexibility
Guaranteed fixed returns that you can count on. You don’t need to worry about highs and lows in the market.
Tax-deferred growth: Since the IRS views an annuity as a retirement savings account, no taxes are made until you take a distribution.
Straightforward: They are the least complicated annuity. Very easy to understand. As long as you aren’t withdrawing money all you need to know is what the guaranteed rate of return is and how long it will be before the money is available.
Principal is safe: Likely the best feature of a fixed annuity is the guarantee that your principal investment can never decrease. The economy can crash as it did in 2008, but even then it wouldn’t matter because a fixed annuity has an iron-clad principal guarantee.
Some cash access: You can withdraw some money if necessary. It’s nice to know that if life throws you a serious financial curveball that you can withdraw money from a fixed annuity if absolutely necessary.
Withdrawal penalties: If you’re under the age of 59.5, you will pay a penalty of 10% on the gains withdrawn.
Limited return potential. People buy a fixed annuity typically because their risk tolerance is rather low. Because a fixed annuity has such iron-clad guarantees of your principal investment, the upside is capped. If you’re looking for double-digit gains on your money, a fixed annuity isn’t the vehicle that will get you there.
M&E charges: The mortality and expense fees can really eat into your returns.
Lack of flexibility: All fixed annuities have an accumulation and withdrawal period. During the accumulation period, you can cash in the policy or surrender it less any stipulated charges. However, during the withdrawal period, you do not have these options. At that point, if your life, if you need access to a large sum of capital, your fixed annuity won't be a resource you can tap into.”
Anthony Martin, Owner and CEO, Choice Mutual
Dispelling Common Myths And Misinformation
“While the vast array of annuity products today offers so much more, the basis of the annuity remains the same; the offer of safety and, as necessary, the guaranty of never outliving one's assets. The information I consider most important about annuities is that which dispels common myths and misinformation. Here, I address a few of those misconceptions:
Annuities have greater risks than other comparable savings or investment vehicles.
There is no safer vehicle than a fixed annuity. Insurance companies are required to maintain reserves far greater than those of banks and credit unions, and state guaranty funds provide higher protection than the FDIC. When AIG faced serious financial woes in 2008, for example, it remained completely solvent in terms of annuity deposits and claims-paying ability, primarily because of the reserve requirements of insurers. Even without the government bailout, no AIG annuity holders were ever in any danger, even if the company had completely dissolved. While variable annuities (VA) do not all offer the same safety of principle as fixed annuities, they offer other advantages, including tax treatment roughly equal to qualified retirement plans such as traditional IRAs and 401(k)s; and a death benefit that guarantees that even in the event of market losses, one's heirs will not suffer those losses. Some VAs, however, do in fact offer principle and/or minimum gain features that make them the optimal choice for persons who wish to remain in the market but need certain assurances.
Finally, this modern era of guaranteed investment products has introduced the equity index annuity (EIA), commonly referred to as the fixed index annuity (FIA). These instruments do not actually invest in equities but offer credited gains relating to any of several available indices of the investor's choosing. One has the opportunity to profit from market gains with no risk of loss.
An annuity is a bad place into which to roll a 401(k) or IRA.
The debate has always raged over putting annuities within tax-qualified plans (IRAs, 401(k)s, etc). The opposition claims that within an annuity, one is somehow paying for tax deferral features that are redundant with those of qualified plans. The fact that both 401(k)s and annuities are tax-deferred is not a strike against annuities; rather, it makes tax deferral a non-issue altogether. One should choose whether or not to select an annuity product based on that product's merits alone.
Annuities have high fees.
Annuities don't have any investment fees that differ from those appropriate for the investment vehicles or features within them. The additional fees in some annuities are attributable to other features and/or guarantees offered by the annuity that would not be available outside of an annuity; namely the ability to guaranty a lifetime income stream and various principal or minimum return guarantees. Ultimately, the nicest thing about having an annuity within any retirement plan is that the account holder automatically has a guaranteed pension, something sorely lacking in most employee-sponsored retirement plans today.”
Rob Drury, Executive Director, Association of Christian Financial Advisors
What Is Best For One Person May Not Be Best For Another
“Annuities provide some certainty in retirement. But the peace of mind and certainty comes at a cost. So is the price of certainty worth it? Like many things in life, it depends! What is best for one person may not be best for another. Before making a decision that will have a big impact on your retirement income it is a good idea to carefully consider all the advantages and disadvantages of purchasing an annuity in retirement. As mentioned, the main benefit of an annuity is the stability and guaranteed return that they provide. Many investors in retirement value knowing what they will receive either in fixed or real terms (allowing for inflation) so they can plan their cash flow in retirement adequately.
The big disadvantage of an annuity is the additional cost the provider will require to cover them for the risk they are taking on (i.e. should the annuity end up costing them more than they initially expect). There are other potential disadvantages an individual should consider and perhaps seek expert guidance on. These potential disadvantages include, but are not limited to, the following: tax rates may change between now and the start of the annuity payment (annuities are taxed as ordinary income), locking into an annuity restricts your flexibility should you wish to draw down more of your funds, annuity prices are based on forecasts of mortality and investment returns and hence they can be difficult for the investor to decipher the exact cost and the balance of the risk and reward. These are just some of the factors to consider. I recommend seeking expert advice to judge your own circumstances and to ensure you make the decision that is most suitable for you.”
Paul Walsh, FIA, FSAI, LLB (CEO), Acumen Resources
Keep In Mind That Proper Diversification Of Your Overall Portfolio Is Important
“For every investment available, it is the right investment for someone and the wrong investment for someone else. The key is to know which is right for you.
A fixed annuity can be a great option for your investment portfolio. Consider the following typical pros and cons.
* Tax-deferred earnings (even if not located in a qualified retirement plan)
* Guaranteed principle
* Typically pays more than a certificate of deposit
* No sales charge or annual fee
* If interest rates decrease over time, the fixed annuity may decrease at a slower pace
* Access to 10% of the value of the annuity each year without a fee
* Surrender charge for withdrawals over 10% will usually disappear over time
* Offers the ability to convert the investment to a guaranteed income for life
* State insurance protection under certain amounts
* Withdrawals over 10% will have a surrender charge in the early years
* Long term commitment
* If interest rates increase over time, the fixed annuity may not keep pace
* Tax penalty for withdrawals prior to age 59½
* State insurance protection not available over certain amounts
* Earning potential lower than variable investment options
A fixed annuity can be a great fit for someone who wants a guaranteed principle, tax-deferred earnings, low fees and will not need the money until they are over the age of 59½ when surrender charges are gone. Keep in mind that proper diversification of your overall portfolio is important. A fixed annuity may be the right fit for a portion of your portfolio. There is no one investment that is appropriate for all of your money.”
Nancy D. Butler, Owner, National professional speaker, Award-winning author, Business Coach, Above All Else, Success in Life and Business
A Certain Level Of Guaranteed Income, But This May be Their Primary Disadvantage As Well
“The primary advantage of fixed annuities, including indexed annuities, is that they provide a certain level of guaranteed income; on the other hand, this may be their primary disadvantage as well. The opportunity to accumulate significant interest using fixed-income investments or alternatives is becoming increasingly challenging due to the global macro-economic environment and pressure on policymakers to keep interest rates low. This is in stark contrast to 2018 when the theme at the beginning of the year was synchronized global growth and interest rates were periodically increased. There is high uncertainty and debate on what policymakers should do and differences of opinion on the direction of the economy, so the possibility that there will be a pivot in direction again exists.
If your primary objective is capital preservation, or not losing what you contribute, a fixed or indexed annuity may be a good alternative solution to a certificate of deposit or just leaving money in your bank savings account. Most fixed/indexed annuities have a specified contract policy period, such as 7-10 years, and there is an understood time commitment that must be met in order to avoid incurring expenses or surrender charges. This could be a drawback if you don’t have access to other sufficient liquid resources and need the money back within the contract period.”
Jeff Nash, CFP®, CPA, Co-Founder/President/CIO, Nashional Financial
As with any potential investment, there are both advantages and disadvantages – fixed annuities are no different. Investors should factor in what the financial experts in this article have discussed, and always do your due diligence before making investment decisions.