In continuing our series on annuities, this week I thought we should focus on why you should (or shouldn't) buy an annuity. Again, this series isn't intended to promote or detract from annuities themselves, but rather to give you a better understanding of them so that you can decide if they are something that is right or wrong for you.
Let's start with what an annuity is and is not. An annuity is a contract issued by an insurance company. It is not an investment like a stock or a mutual fund. This is where I think the problems start for a lot of people concerning annuities. Since they are insurance company issued contracts, many of them can be sold by insurance agents and not just financial advisors. Because they are insurance company issued contracts, they provide certain guarantees (backed by the financial strength of the insurance company) as opposed to a pure investment, which does not provide any guarantees. An annuity is designed to provide you with income whether it be immediate, or in the future for your lifetime, or a specific period of time. This is the main reason to buy an annuity, income, period. An annuity can provide income once you turn on the income from it, and it can provide that income to you regardless of how long you live. Much like a pension or social security pays you for as long as you live, an annuity can be designed to do the same thing. No other vehicle can provide this which is why annuities should never be compared to traditional investments. The comparison is flawed as soon as it is made. Comparing annuities and traditional investments are like comparing apples and oranges.
What are the typical features of an annuity? They typically do not have a sales charge to buy them, but rather they impose a surrender charge for a designated period of time should you take your money elsewhere. The benefit is that all of your deposit is working for you from day one. The surrender charge is imposed because the company has obvious expenses in setting up the contract as well as commissions (if not fee-based) to the person who sold you the contract. This is similar to how a permanent life insurance policy works. The annuity can contain riders which may guarantee returns for future income purposes, death benefits, or principal protection. Often, these riders come with an additional fee. Unlike non-IRA investments, annuities have named beneficiaries which bypass your will. A side note- annuities, life insurance policies, and IRAs all pass by beneficiary designation and not via your will so they are not typically included in the operation of your will unless you name your estate as the beneficiary, which is not frequently recommended.
What are the pros of an annuity?
1. Lifetime income. Only an annuity will typically provide you with income for life regardless of whether or not you run out of principal. This is clearly the primary selling point of an annuity.
2. Principal protection. Some annuities will provide protection against a loss of principal which many retirees favor.
3. Tax deferral. Interest earned in annuities unlike other non-IRA investments is not taxable until withdrawn. Be careful however, when the withdrawals are made, the interest comes out first and is taxed as ordinary income which can be less favorable than traditional investments which are taxed as a capital gain.
4. Beneficiary designations. Naming a beneficiary can allow the death benefit proceeds to avoid probate.
What are the disadvantages of an annuity?
1. Annuities are complex. The whole reason I am writing this series is because annuities are poorly understood by most people often due to their complexity and multitude of moving parts.
2. Taxation. While the tax deferral of an annuity is a selling point, as mentioned earlier, income coming out of an annuity may not be as favorable as traditional investments.
3. Potentially muted returns. Wile we all love guarantees, sometimes those guarantees come at a price and one of the possible costs is that an annuity may not earn as much as traditional investments. Retirees may not care as much about this as younger investors may because they may be more concerned with protection of principal but it is worth noting.
4. Fees. Some annuities, typically variable annuities can become very expensive if you add multiple riders, etc. to the contracts. Remember, all those bells and whistles can be great, but they come at a price and it can be a very expensive price so be careful what you add onto your annuity contract.
Seeing annuities through this lens can hopefully help you decide if an annuity is a suitable product for you to consider purchasing.
Fixed Index Annuities are not a direct investment in the stock market. They are long term insurance products with guarantees backed by the issuing company. They provide the potential for interest to be credited based in part on the performance of specific indices, without the risk of loss of premium due to market downturns or fluctuation. Fixed Index Annuities are designed for long term investors. These annuities do not participate directly in any stock or equity investments. You aren't buying shares of stock or an index.
Dividends paid on the stocks on which the indexes are based don't increase your annuity earnings. Interest crediting may be based on one or more different methodologies. Please read the product prospectus for details. If you take money from your annuity early, you may lose some or all of your credited interest.
If you take out all (a full surrender) or part (a partial surrender) of the money, you also may have to pay a surrender charge. The amount of the charge depends on how long you've had the annuity and how much you withdraw. They may not be appropriate for all clients.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures.