Pros and Cons of Fixed Annuities
For retirees, the most attractive feature of fixed annuities is the assurance that it’ll provide a fixed income for life. But all investments have their good and bad points; and fixed annuities are no different. Let’s overview some of their advantages and disadvantages summarized in the table.
Advantages
The three important features of an annuity are tax-deferred accumulation, guarantee of principal, and guaranteed life income. The tax-deferred accumulation – in comparison to a similar taxable investment - allows for greater accumulation since earnings are not taxed away annually.
Annuities have been conservative vehicles for investment. Of course you should always check out the strength of any insurance company you’re considering buying from. A good source is to get the Comdex rating of 80 or better from Vital Signs (see a financial professional) or a Weiss rating of B or better.
With the guaranteed life income payout option, you don’t have to worry about market downturns that could rob you of income. Also if you can put off your payout until later, you’re monthly payout will increase not only from increased earnings but from your reduced life expectancy.
Disadvantages
Because an annuity is a long-term investment with tax-deferred status, the IRS will levy a 10% excise tax penalty on any withdrawal before age 59 ½.
Annuity fees can significantly cut into any withdrawals taken early in the accumulation years. So plan on holding off for 10 years or so to let your earnings offset this effect.
Since your money is placed with an insurance company in an annuity contract, you have little control over the rate of return on your investment. When you buy, find a company that has a history of providing competitive returns If you ask for the interest rate history, you will get it).
Although with a fixed annuity you’ve eliminated the possibility of market risk on your investment you have created the risk of losing purchasing power. After beginning payments to you you’re not able to make any adjustments in case of higher inflation rates. However, if the rate history looked good, the company may be more reactive to raising rates when possible.
Choosing a lifetime income leaves generally leaves no residual investment for your heirs. You can choose options that remedy this, but at the cost of a lower monthly payout.
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Fixed Annuities – Pros and Cons |
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Advantages |
· Tax-deferred earnings · Assurance of lifetime income · Not subject to market downturns · Longer deferred gives greater payout per month |
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Disadvantages |
· Early (before 59 1/2) withdrawals are penalized at 10% of withdrawal · Withdraw too soon after contributing can bring high fees and · Purchasing power of fixed payout can be degraded by inflation · Lack of benefits to heirs |
Annuities once annuitized cannot be surrendered for value. Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty. Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses.
–Bob Richards
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Tags: fixed annuities
November 27th, 2009 at 9:31 am
Even though there are quite a few negatives, I would definitely opt for a fixed annuity because it is less of a risk than investing in the stock market and I would go with a safer option rather than a risky one.
January 4th, 2010 at 11:32 am
there are many pros and cons to an annuity but it really comes down to your specific situation. many people get an annuity with the plan of receiving payments throughout retirement. but things happen and if you ever need immediate cash, you can sell your annuity for a lump sum payment. it’s good to have options.
January 22nd, 2010 at 4:26 am
Fixed annuities have their pros and cons but at the moment can they compete with a structured investment? Structured investments are insured by the FDIC and follow the stock market offering great returns. Whats your thoughts on the comparison?
January 25th, 2010 at 8:02 pm
Annuities once annuitized cannot be surrendered for value. Income from deferred annuities is taxed as ordinary income fashion and withdrawals prior to age 59 ½ are subject to a 10% penalty.
January 26th, 2010 at 11:09 pm
Awesome article again. The best site I’ve come across to help me prepare for my retirement. Thanks a bunch. Cheers
February 2nd, 2010 at 8:26 pm
I did not know annuities once annuitized cannot be surrendered for value. Thank you for teaching me somthing new! Good post.
February 6th, 2010 at 8:12 am
Very helpful post. In my opinion the Pros of fixed annuities are stronger than the Cons.
February 8th, 2010 at 5:21 am
An important factor is that of tax liability. In case of tax deferred fixed annuities, the earnings within the annuity are not subjected to taxability until they are withdrawn. This may offer its own advantages, like tax control, along with a higher potential for growth
February 8th, 2010 at 9:14 pm
Thank you for a comprehensive overview of all PROs and CONs, it definitely inspired me to do more reading on annuities.
February 9th, 2010 at 11:24 pm
Many people get an annuity with the plan of receiving payments throughout retirement. Even though there are quite a few negatives, I would definitely opt for a fixed annuity
February 10th, 2010 at 1:09 pm
If one is worried about the risk of inflation, yet, wants the stability of a guaranteed return similar to a traditional fixed annuity, then an equity-indexed annuity may be a good option. It is tied into an index like the S&P 500, and provides rather exceptional returns compared to a traditional fixed annuity when there is a rising market. However, if the market were to fall, your annuity would not lose value. In fact, they have a no loss clause, stating that no matter what happens to the market, your money is guaranteed. A safe investment vehicle with a no loss clause that can pay a percentage of a climbing market, would be a good alternative to a fixed annuity, if inflation was a concern. This is why it is important to check the financial strength ratings of the carriers you are considering.
Jason Hawkins
Owner
The Koenig Group LLC