Five Annuity Criticisms Explored
Annuities have developed a mixed reputation in the world of retirement planning. The security offered by guaranteed monthly income during retirement sounds great, but some people have formed the opposite opinion. Many have said that annuities are ineffective, and are only a tool for advisors and companies to make large commissions off fees and unavoidable penalties. Much of the negative commentary on annuities does little to balance its viewpoint with the reasons the supposed drawbacks exist.
If annuities were neither effective nor useful, they never would have emerged as part of retirement planning to begin with.
Annuities are very different from traditional methods of saving for retirement. The following five criticisms are often brought against them:
Annuity plans cost more and pay out less than managing retirement investments directly.
While it’s true that purchasing an annuity is expensive, cost is only half the story. Annuities are not mutual fund investments that rise and fall—they are valuable retirement funds that guarantee monthly payments no matter how the market is moving. This level of security makes an annuity not just an investment but also an insurance policy; higher fees are the insurance premium payments that cover the risks.
Annuities are completely rigid in their pay structure and do not accommodate for changing circumstances.
Though annuities need to be restrictive in order to work, they are designed to provide for some change. Usually the greatest concern is the change in the value of money. A fixed annuity pays out a consistent cash amount. Though the payments might be enough at the start of retirement, 20 years later, their value may have dropped off considerably. “Variable” and “indexed” annuities provide a solution to this problem.
These annuities grow with the market, providing more money as inflation increases.
Additionally, several annuities offer contingency policies that allow for advanced payments to be made to the annuity holder. These added funds can provide much needed cushioning if extra cash is needed for a medical emergency or other unexpected event.
Once an annuity is purchased it is impossible to get out of it without forfeiting a huge part of your investment.
Cancelling an annuity draws fees from two places: the insurer and the government. The insurer imposes “surrender fees” to anyone who cancels an annuity early. Most surrender fees decrease with each passing year, disappearing entirely by the seventh or eighth year.
As for the government, it imposes a 10 percent tax if the annuity is withdrawn before retirement. This tax, which is also levied on IRA and 401(k) plans, can be avoided if funds are transferred from one annuity to another. Though surrender fees could still apply, these annuity transfers allow owners to exchange annuities if a better fitting one is discovered in the future.
The most important thing to remember about annuity restrictions is that they are largely meant to be good for the plan holder. The goal of an annuity is to turn a lump sum of money into a dependable, regular income. Restrictions keep plan holders from overdrawing or mismanaging their money all at once.
Annuity plans make money by keeping a huge percentage of your initial investment.
An annuity is like putting money into a CD at a bank. The bank is able to pay you interest because they use your money to fund their loans and investments. Similarly, insurers earn profits by professionally investing the money used to fund the annuities. They keep some of the money they earn and return the rest to grow the annuity.
Insurers guarantee the return they will provide; even if an annuity holder passes away, the unpaid value of the initial investment will be returned to designated beneficiaries.
Annuity plan sales have some of the largest commissions of any retirement investment. They are just a way for an insurer and an advisor to make money off me.
Insurance companies are able to make quite a bit of money off an annuity plan. But profits don’t come from selling a product at an inflated price: the fixed, long-term nature of annuities means that insurance companies are able to use them effectively.
Since investment companies rely on investing for income, the more time they have to work with the fund, the better. This is why surrender fees exist for only a few years, insurers were relying on the down payment to earn back the costs of creating the annuity.
Since the use of money is so profitable for insurers, they are willing to pay advisors a good commission for directing business to them. Though this seems like it might turn an advisor into a pushy salesman, anyone who is licensed to sell financial products is legally obligated to be truthful and avoid unsuitable investments.
So What Do I Do?
Annuities are unique retirement vehicles that serve a unique purpose. They are not ideal in every situation and certainly are not meant for everyone to use.
The regular payments of annuities provide a lot of stability, but their expense can limit options during retirement. Even if a person has enough money to create an annuity capable of paying for all the enjoyments of retirement, it is likely that the income would become unnecessarily large as he or she grows older.
An annuity functions optimally when it is treated as a base for retirement spending. The monthly income provided by an annuity can be used to cover necessities while money from another retirement fund can be used for additional spending. This way, retirees can be assured that they will always receive enough to make ends meet, but still maintain easy access to the money they wished to use for enjoying their retirement.
Ultimately, the choice to purchase an annuity plan is up to you. It is important to gather as much information as possible before making a decision. Though they are often unjustly criticized, they still can cause unnecessary problems for those who do not take the time to understand the effect they can have.
As with all large financial commitments, discuss annuity purchases with your financial advisor before making any commitment. Safe harbor Fiduciary is dedicated to helping you understand your retirement options and will strive to address all your concerns.
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