12 Sep Are Annuities Bad, Ugly Or Good?
It all depends on the kind of annuity and what your specific needs are. An annuity is the investment of a lump sum of cash to produce a monthly income stream either for life or a fixed period of time. The income may start right away (immediate annuity) or at some future point in time (deferred annuity). The issuers do not insure or protect the funds. It isn't always a given how large the future monthly checks will be - it depends on if the annuity is variable or fixed.
There are all different kinds of annuities that are available:
1. Complicated variable annuities tend to be oversold to people who don't completely understand them. They are difficult to comprehend and quite complex.
2. Large commissions are earned by variable annuity sales people; so they may be quite driven to try to sell annuities to you. Sales people working on commission to not necessarily have your best interests at heart.
3. Annuities should only be purchased if the benefits are very compelling and complements a couple or individual's overall financial picture. Frequently, annuity sales people focus on "closing the deal" and really don't consider the entire financial picture of the buyer.
Annuities are not suited for everybody. If you are receiving Social Security payment, then you have an indexed, fixed annuity already that continues to pay you for the rest of your life. An annuity's insurance element, if nothing else, means you "lose" when your life ends up being shorter than your peers since your monthly payments will be redirected by the insurer to the other annuity investors who end up outliving you.
So what is good, bad and indifferent about annuities?
The Good About Annuities:
1. Inexpensive variable annuities may be a good fit if your income is high and are in a higher tax bracket if you are completely maximized on your IRA and 401(k) deferrals and are expecting that after you retire you will be in a lower tax bracket. With wow cost variable annuities you have less than 1% per year charge.
2. A low cost variable or fixed annuity might make sense if you would like to take a lump sum and convert it into an income stream and you are able to afford to have a certain sum of money tied up for an extended time period (or forever potentially).
3. Longevity annuities might be a good choice if you are worried about outliving your assets can can afford to lock some of them into an annuity. You can set up an income stream with a longevity annuity late in life. For instance, a woman named Alice is 73 years old, is still in good health and has a history of longevity within her family. She invests a maximum of 15% of her total investments in a deferred fixed annuity. She will start receiving a monthly income from her $150,000 once she turns 80 years old; she will continue to receive those payments until she dies. If she passes away before she receives any payments, the principle might be returned without interest. However, if she dies after she starts receiving her income stream then she might forfeit the whole annuity.
4. There are new initiatives from the government that allow 401(k) investors to have part of their account placed into an annuity. This is due to concerns about 401(k) returns being poor since investors do not always make wise investments and the option of an annuity is viewed as a way of proving retirees with more certainty and predictability.
5. Charitable annuities are often a great way to make tax deductible donations to charities and then receive part of the donation as an income stream for life.
The Ugly And Bad About Annuities:
1. Variable annuities may tie you down with serious surrender penalties (up to 15 years or even longer) and 3-4% annual fees.
2. Are you consider variable annuities that come with a lot of bells and whistles that aren't very clear to you? If so, I advise you to get a second opinion from somebody who doesn't profit from the annuity industry.
3 Are you in a moderate or low tax bracket? Purchasing an annuity using after-tax dollars (for deferring your investment income) might be disappointing if you end up with a higher income tax bracket once you retire due to either the fact that in general tax rates are likely to increase in the future, or from significant RMD distributions from your 401(k) or IRA.
4. Also, if you buy an annuity using after-tax money, it might not be a good tax decision for you to make. You will be trading lower tax rates on capital gains to higher tax rates on ordinary income on all of your annuity gains.
5. If you are wanting to defer income is isn't necessary to have an annuity as part of your IRA since an IRA is ta-deferred already. Having an annuity within an IRA is mostly redundant unless you are specifically wanting the mortality/insurance benefit.
6. Your overall investment and financial strategy might be augmented by a fixed annuity. However, currently interest rates are very low. You would be a lot better off purchasing a fixed annuity when you can lock in a higher interest rate.
7. Your money could end up getting tied up for the rest of your life. You cannot undo an after-tax annuity. After the money goes into an annuity structure, it stays there. If you want or need to get out of an ugly or bad annuity, it can be rolled over into an annuity that is less expensive if you don't have surrender penalties any longer. However, the annuity structure cannot be terminated.
8. Are you planning on leaving your variable annuity to your heirs? Annuities that are invested in equities do not make good inheritances because there isn't any step-up in basis to the value at the date of death in the position when the annuitant (initial owner) dies.
In summary, fixed annuities might potentially be beneficial for some individuals when interest rates are higher.
We totally understand things can be confusing when it comes to annuities.
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