There are many retirement investment accounts to consider, including 401(k)s and IRAs. Annuities are another retirement investment option, though they’re widely misunderstood.
Unlike other retirement accounts which are provided by lenders, annuities are sold by insurance companies. They’re best described as a hybrid between a retirement account and an insurance policy. They are customizable and can provide a reliable stream of income during your retirement years.
Looking to diversify your retirement portfolio? Here’s what you need to know about the pros and cons of investing in an annuity.
What are the Advantages of an Annuity?
Annuities offer many advantages. Here’s why annuities have become increasingly popular.
Annuities Offer Regular Payments
Annuities offer regular payments during retirement. For some, these payments provide much needed supplemental income. If you’re worried that you haven’t saved enough to cover regular expenses, annuity payments can be a huge help.
The amount of your annuity payments are dependent on the type of annuity you have and contract terms.
Potential for Tax-Deferred Growth
The money used to fund an annuity is tax-deferred. This means that you contribute money before paying taxes. Taxes are collected at the time of payment.
During the time that you contribute funds, your money can grow significantly. This is very similar to how 401(k) contributions grow.
Guaranteed Rates of Return with a Fixed Annuity
Investing money into any retirement account comes with risk. However, a fixed annuity contract typically includes certain clauses that prevent you from losing money.
With a fixed annuity, it’s guaranteed that you’ll get back a certain percentage of your principal investment. While the percentage is usually low, you’re guaranteed to earn more than your original investment amount.
What are the Disadvantages of an Annuity?
While annuities offer all sorts of perks, there are some disadvantages to be aware of as well.
Certain Annuities Can be Very Expensive
Variable annuities can be expensive. If you’re considering a variable annuity, make sure that you understand all the associated fees, including:
- Expense risk fees
- Administrative fees
- Mortality fees
These fees typically range between 1-1.25% of your account’s value. Consider a fixed or indexed annuity to limit other fees and expenses.
Difficult or Impossible to Get Out Of
Once you contribute money to fund an annuity, you may not be able to get it back or pass it onto your beneficiary. While you may be able to move the money into another annuity, you may be subject to all sorts of fees.
Annuity benefits also go away when you die. The money cannot be passed onto a beneficiary, even if you have plenty of funds left at your time of death.
If you need to withdraw money from an annuity before a certain time frame, you may be subject to hefty surrender fees. Most annuity owners are expected to leave their investment untouched for 6-8 years, or longer.
It’s also important to note that anyone under the age of 59 1/2 may have to pay a 10% early withdrawal penalty on any money that is withdrawn.
Like any retirement investment account, annuities have their pros and cons. Know how annuities work and choose the right type if you decide that an annuity meets your retirement needs.