You’ll likely come across annuities as you evaluate your retirement savings options. An annuity is a contract between an investor and their insurance company. The investor pays the insurance company in either a lump sum or fixed monthly premiums.
An annuity can be either immediate or deferred. Immediate annuities can be paid over a period, creating future cash flow. On the other hand, deferred annuities grow tax-deferred, ensuring income that starts on a specific date.
While annuities guarantee retirees an income stream, they can also come with higher costs and limitations. Let’s explore the pros and cons of this retirement vehicle below.
When Would You Want an Annuity?
Investors often purchase annuities when they are worried about outliving their assets in retirement. This concern often comes as retirees near the end of their accumulation phase and start to move into their distribution phase.
So, if you’re highly concerned about replacing your income in retirement, an annuity could be beneficial. There are three general annuity structures:
- Fixed: A fixed annuity could almost act as a pension, as you’ll have an annual guaranteed income to budget your retirement.
- Variable: With a variable annuity, your returns vary based on market performance—if it does well, you receive larger payments; if it performs poorly, you receive smaller payments.
- Indexed: This type of fixed annuity offers returns based on the performance of a market index, like the S&P 500.
What Are the Drawbacks of Annuities?
The downside to annuities is their complexity and potentially higher fees than other savings vehicles, like IRAs and brokerage accounts. As Bankrate notes, these fees can include:
- Commissions (1 percent to 8 percent)
- Administrative fees (0.3 percent)
- Surrender charges (0 percent to 10 percent)
- Mortality expenses (0.5 percent to 1.5 percent)
- Expense ratios (0.06 percent to 3 percent)
- Riders (0.25 percent to 1 percent)
- Rate spreads (2 percent)
Not to mention, annuities often have higher minimum investment amounts. For example, Charles Schwab has a minimum of $100,000 for all annuity contracts. While mutual funds and ETFs can also have minimum investment amounts, they are generally lower than annuity contracts.
ETFs and mutual funds often provide more liquidity than annuities. In contrast, annuities are long-term commitments that can have significant costs if money is withdrawn early in the contract.
Is an Annuity Right for You?
When investing money, it’s essential to identify your goals and needs. An annuity offers low-risk fixed returns, but it often has higher expenses than low-cost exchange traded funds. Managing your investment expenses can dramatically impact your investment returns over the long run.
Carlson Investments is not an insurance agency, so we recommend calling your annuity company directly. If you’re unsure of what may be best for your situation, contact us to discuss your investing options today!
Carlson Investments does not provide tax, legal, or accounting advice. This content has been written for informational purposes only. Always consult your individual tax, legal, or financial professionals for advice tailored to your situation.
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