Often marketed as a secure retirement income source, annuities are popular financial products. However, they’re also one of the most misunderstood personal finance products out there. As a result, annuities have gained a negative reputation that discourages some people from investing in them.
Here, we’ll explore and debunk some of the most common annuity myths. This, in turn, will help you make an informed decision about whether they might meet your financial goals.
Myth #1: Annuities Are Too Complicated
A common myth about annuities is that they are too complicated for the average investor to understand. While annuities do have different rules, fees, and benefits, they aren’t inherently complicated. Annuities generally involve paying a premium (either a lump sum or monthly installments) to receive periodic payments for a set period or for life.
Further, an annuity can be classified in three ways: fixed, variable, or indexed:
- Fixed annuities offer guaranteed payments.
- Variable annuities are based on the performance of selected investments.
- Indexed annuities track an index, such as the S&P 500, and are a middle ground between fixed and variable annuities.
In short, you can understand annuities with a little guidance. This is especially true if you choose the type that aligns with your goals.
Myth #2: Annuities Have Exorbitant Fees and Costs
There are a lot of people who believe annuities are unworthy of consideration due to their prohibitive fees. Although some annuities, particularly variable ones, can have high fees, not all annuities are expensive. So, if you are considering an annuity, you should be aware of the different types of fees.
Among the most common fees are;
- Mortality and expense (M&E) risk fees. These are typically found in variable annuities and cover the insurer’s risk.
- Administrative fees. In most cases, they are nominal, covering administrative expenses.
- Rider fees. Additional fees may apply to optional benefits, such as death benefits or guaranteed withdrawal riders.
Because fixed annuities are less complex than variable annuities, they generally have lower fees. In addition, some annuities have no-load options. Because of this, fixed and immediate annuities come with minimal to no extra fees.
To make the most informed decision, reviewing all associated costs with a financial professional is essential.
Myth #3: Annuities Are Only for Older Investors
Often, annuities are assumed to be solely for retirees. Annuities are indeed popular with those approaching retirement. However, they can also benefit younger investors, especially as tax-deferred savings vehicles. With indexed or variable annuities, young investors can enjoy tax-deferred growth over time — especially if their contributions grow tax-free.
Furthermore, specific types of annuities allow investors to receive payouts at any age. Deferred annuities, for example, allow funds to grow until the investor is ready to receive income, which may take decades. As such, annuities can be a valuable part of people’s long-term savings plans.
Myth #4: Annuities Don’t Offer Liquidity and Lock Up Your Money
People hesitate to invest in annuities when they believe they will lose access to their funds. Although annuities are designed for long-term investing, most offer early withdrawal options, albeit with some penalties. In many annuities, withdrawals are subject to surrender fees during the surrender period. Over time, however, these fees often decrease and eventually disappear.
Furthermore, riders like free withdrawal provisions allow investors to withdraw a portion of their funds without penalty every year. An annuity with a 10% free withdrawal rider, for example, will enable investors to withdraw 10% of their value without incurring fees. Although annuities are designed to prioritize future income, they may still have limited liquidity options.
Myth #5: If You Die, the Insurance Company Keeps All Your Money
People mistakenly believe that if they pass away early, any money in their annuity will go to the insurance company, leaving nothing for their heirs. Although this is possible in some instances, there are alternatives. Check this question out before purchasing and ensure your heirs are on the annuity paperwork.
It is common for annuities to include death benefit riders that allow the remaining balance to be transferred to beneficiaries upon death. Alternatively, a joint-life annuity can provide income to a surviving spouse after the death of the primary holder.
Annuities can include riders that guarantee the return of premiums or a guaranteed period, or they can pay out for a minimum number of years. Funds can continue to benefit loved ones with these provisions in the event of an early death.
Myth #6: Annuities Are Too Risky
Because of fluctuating markets and potential losses, annuities are sometimes viewed as high-risk investments. This myth often arises from the confusion surrounding indexed and variable annuities. Variable annuities are indeed tied to the stock market, which can fluctuate. However, they often include guaranteed income riders that guarantee payouts even if the investments perform poorly.
Conversely, fixed annuities are guaranteed by the issuer and backed by their insurer. Often, state guaranty associations protect annuity funds against an insurance company’s failure. As a result, annuities can be as safe as any other insured financial product.
Myth #7: Social Security and Pensions Make Annuities Unnecessary
There is a belief that Social Security and pensions make annuities obsolete because they guarantee retirement income. However, Social Security benefits might not cover everything. Additionally, fewer employers offer pensions.
Annuities, however, can be used as a supplemental income source to fill gaps, thereby providing additional security. In retirement, they’re especially useful for those concerned about outliving their savings.
Moreover, due to their flexibility, annuities can complement other income sources. Deferred annuities, for example, can provide steady income after other retirement savings have been exhausted. As an income bridge, annuities contribute to a holistic retirement plan.
Myth #8: Annuities Are Only Worthwhile if You Live a Long Time
For those who might not live long, annuities are a “bad deal” since they are only beneficial if you have a long life expectancy. Contrary to this myth, annuities offer a variety of options.
For instance, in a life with period certain annuity, the annuitant receives an income for life with a guaranteed payout after a specified period. In other words, the annuitant receives payments for life, and if they die before the chosen period, the beneficiary receives the remaining payments. In most cases, the period certain lasts between ten and twenty years.
Furthermore, joint and survivor annuities continue to pay benefits after the primary annuitant’s death. In other words, the annuity pays out a reduced amount during the annuitant’s lifetime and then pays out a portion to the surviving spouse after the annuitant dies. The amount paid to the surviving spouse is known as a “survivor annuity.”
Conclusion
Although annuities are versatile, flexible, and sometimes complex, their reputation has been tarnished by negative publicity. Despite not being a one-size-fits-all solution, they can provide income security, tax-deferred growth, and even a way to leave the legacy you want to be there for your kids.
By debunking these myths, we can better appreciate the value annuities can add to a well-rounded financial plan. You should, however, consult a qualified financial advisor before investing in an annuity to ensure that it aligns with your goals and risk tolerance. After all, if you have the correct information, annuities can be a valuable part of your retirement planning.
FAQs
What is an annuity?
Often used for retirement planning, annuities provide a steady stream of income.
Payments are made into the annuity in a lump sum or a series of installments, and the annuity company invests the money. As a return, you receive regular payments for a fixed period of time or the rest of your life.
How do annuities work?
An annuity is divided into two phases: the accumulation phase and the payout phase.
- Accumulation phase. Your money is invested into the annuity as a lump sum or through regular payments. Until you withdraw the money, the earnings grow tax-deferred.
- Payout phase. As soon as you purchase the annuity, you begin receiving income payments. The payments can be fixed or variable and last for a specified period or forever.
Are there different types of annuities?
Annuities come in several forms, including;
- Fixed annuities: Despite their guaranteed rates of return, they have a limited growth potential.
- Variable annuities: Similar to mutual funds, these allow you to invest in a variety of subaccounts. While investment returns are not guaranteed, the growth potential is greater.
- Indexed annuities offer both fixed and variable features. They usually have a minimum guaranteed rate of return, but the potential for higher returns depends on the performance of a specific index.
What are the advantages of annuities?
- Guaranteed income. Many annuities provide lifetime income guarantees.
- Tax deferral. Your annuity earnings grow tax-deferred until you withdraw them.
- Protection from market volatility. It is possible to protect yourself from market downturns with some annuities.
What are the disadvantages of annuities?
- Fees and Expenses. Annuities can have high fees and expenses.
- Lack of liquidity. If you withdraw money early, you may have to pay penalties.
- Complexity. In some cases, annuities can be complex products.
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