Annuities: Potential Advantages And Disadvantages

An annuity is an investment product issued by an insurance company designed to grow in value and then pay out a stream of guaranteed monthly payments starting at a later, set date – usually corresponding to your retirement. While there are a variety of types of annuities, you can use the points listed below as a general guideline to decide if they are worth it for you to investigate further.

Advantages

  • If you've maxed out your contributions to other accounts offering tax-free retirement growth – like a 401(k) or IRA - an annuity could give another place to stash an additional nest egg.
  • There are no annual contribution limits, which sets annuities apart from other tax-deferred accounts like a 401(k) or IRA.
  • Annuity contracts do not have to be listed as assets on the Free Application for Federal Student Aid (FAFSA) form by parents applying for aid for their child's education.
  • Many investors prefer the stability and relative safety of the guaranteed return provided by annuities. The trade-off though is that annuities don’t offer the same kind of growth potential that other investments – such as stocks – do.
  • Because you assign a beneficiary or beneficiaries for your annuity, the money shouldn’t be subject to probate fees or delays upon your passing. The benefit to your beneficiary is the higher of the current value of the annuity or the total amount you paid into it.

Disadvantages

  • High fees can often be associated with annuities, which can make them among the most expensive investment products on the market. Make sure you are aware of all fees, including initial commissions, ongoing investment management fees and early withdrawal fees. To test whether it is really worth it to take on the fees for an annuity, compare the cost of the annuity with a no-load mutual fund.
  • Annuity income will be taxed just like ordinary income, so there is a chance that your tax rate could go up between now and the time you want your annuity to start paying out.
  • Annuities may restrict your flexibility since early withdrawal often means paying a penalty. Experts refer to this as illiquidity. Some annuities do allow penalty-free partial withdrawals or disability/hardship exceptions to fees. Make sure you understand exactly when you will be able to access the money in the annuity and whether or not you will pay fees to do so.
  • Many observers have pointed out that annuities restrict the investment options available and saddle investors with limited choices.
  • Another common factor cited by financial professionals as a potential drawback of annuities is their complexity. Investors may not be able to fully understand exactly what the investment entails and thus may be at the mercy of the insurance company selling the product to be educated about the risks and rewards.
  • Annuities aren’t insured by the FDIC or NCUA, but rather are covered up to a certain amount specified by individual states. For this reason, it’s important to understand how you are protected in your state should the insurance company offering the annuity go out of business.
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