Annuities: The Good, The Bad, and The Ugly

Deciding whether annuities are a smart financial decision comes down to where you are in your financial journey and your individual goals and objectives. In today’s increasingly complex and ever-changing financial industry it is paramount to make sure you are educated on the advantages and disadvantages that these insurance products offer. As with deciding on purchasing any financial product, you need a well-defined, well-documented financial plan, to make sure that it is the right fit for YOU.

Let’s start with the basics. What is an annuity? An annuity is a contract between you and an insurance company that requires a payment by you upfront, or over periodic intervals of time, in exchange for guaranteed payments to you either immediately or at some point in the future. While there are many different annuity products, all with varying features depending on the company you purchase them through, they broadly fall into 5 basic categories.

Immediate Annuities: With an immediate annuity you begin to receive payments typically within one year.

Deferred Annuities: You receive payments at a future date.

All fixed, variable, and indexed annuities can be issued as either immediate or deferred contracts. Some require a lump sum contribution to start, or periodic payments over time.

Fixed Annuities: You receive a fixed rate of interest and a fixed amount of periodic payments.

Indexed Annuities: Combines securities and insurance features that credit you an interest rate based upon the performance of an underlying index(es). Your principal is always protected but you are capped on upside potential.

Variable Annuities: You invest in an underlying security (typically a mutual fund) and your payout is determined based on the underlying securities performance, the amount you put in, and expenses. While there is a higher upside, there is also downside risk if the securities do not perform well.

The Good:

  • Guaranteed Income: With pension plans becoming few and far between, annuities are one of the only ways to get a guaranteed, predictable income stream for life. Potentially filling an income gap that social security and/or a pension may not cover.
  • Tax Deferred Growth: One of the main tax advantages of annuities is they allow investments to grow tax-free until the funds are withdrawn. This includes dividends, interest and capital gains, all of which may be fully reinvested while they remain in the annuity. This allows your investment to grow without being reduced by tax payments
  • Annuities are tax-deferred. But that doesn’t mean they’re a way to avoid taxes completely. What this means is taxes are not due until you receive income payments from your annuity. Withdrawals and lump sum distributions from an annuity are taxed as ordinary income. They do not receive the benefit of being taxed as capital gains.
  • Death Benefits: If you die before receiving benefits, your beneficiary receives payment.
  • Stability of Portfolio: With most fixed and indexed annuities you can count on getting back at least what you put in. This predictability can help balance out other investments that may be more prone to market swings.
  • Long-Term Care: With the increasing costs of healthcare, some companies have started to offer riders that provide tax-free payments for nursing homes, assisted living, and home healthcare. These riders are an additional charge and are still a relatively new offering for the industry.

The Bad:

  • Liquidity: Annuities require you to give up access to the funds for a specified amount of time; typically, anywhere from 2-10 years.
  • Control: Once purchased, you cannot get out of the contract until the surrender schedule has been met. If surrendered early they are subject to high surrender fees.
  • Tax Penalties: If withdrawn before age 59.5 you may also have to pay an additional 10% early withdrawal penalty for qualified accounts, a 10% penalty may be assessed for any earnings on non-qualified annuities.
  • Opportunity Risk: Many annuities cap your potential upside, and you may be able to get a higher long-term rate of return in the market.

The Ugly:

  • Complexity: Annuity products have many riders, payout options and features which add to the complexity of deciding which is best for you.
  • Fees: Some annuities (mainly variable) come with high fees. Between administrative fees, mortality and expense, mutual fund expense ratios, rider charges, etc. you may be paying upwards of 2-3%.
  • High Commissioned Product: Annuities typically pay an advisor in the form of an upfront commission sometimes as high as 6-8% of the premium for fixed indexed annuities, immediate and deferred annuity commissions range from 1-4%. This is one of the reasons for them being over-recommended. If your advisor is recommending an annuity, be sure to ask them how it fits into your plan, why they are recommending it, and how much they are making on the transaction.

In summary, annuities can be a great product to add to your overall financial plan. However, they are not appropriate for everyone.  If you are thinking of purchasing one or if your advisor is recommending it, make sure you know the ins and outs. Our dedicated team here at BerganKDV can help guide you through the decision to make sure it is in your best interest. Contact us today to learn more about how we can assist with your wealth advisory needs. Let’s have a conversation!


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The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Investment advisory services and fee-based planning offered through BerganKDV Wealth Management, an SEC Registered Investment Advisor.

CATEGORIES: Risk Management and Insurance | Uncategorized | Wealth Management
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