Guaranteed income for life sounds like a great deal.
Its what many annuities promise, yet nothing is ever as good or as easy as it seems.
What Is an Annuity?
Annuities are not investments theyre contracts.
And like many contracts, annuities can get complicated.
Probably not as good as youd like.
It always seems like an uphill battle to build (and keep) a decent amount in savings.
But what if your car breaks down, or you have a sudden medical bill?
Ask one of these companies to help…
People say theyre confusing and they can be.
How Do Annuities Work?
Disbursements can begin almost immediately or at some designated point in the future.
The payouts often last the lifetime of the policy holder.
You choose how frequently you receive future annuity payments, such as monthly, quarterly or yearly.
As traditional company pensions became less common, annuities gained traction.
So whats in it for the insurance company?
To offset risk, the company charges a bevy of fees for management and administration.
These are called joint and survivor annuities and are popular for married couples.
What Are the Different Types of Annuities?
An immediate annuity begins paying within a year of purchase.
Sometimes the waiting period is about 30 days.
Deferred annuities begin paying out sometime in the future.
You make an initial lump sum payment or a series of payments to the life insurance company.
That money grows tax-deferred throughout the accumulation process.
you’re able to choose how long the money accumulates in a deferred annuity.
The typical range is 10 to 30 years.
In exchange for payments during the accumulation period, the annuity company promises to send you future income payments.
Once the distribution phase begins, youll begin receiving regular payments from your deferred annuity.
A fixed annuity pays a guaranteed amount based on a fixed rate.
Its considered relatively low risk.
Fixed annuities tend to have much lower costs and fees than variable or indexed annuities.
Life insurance companies invest the funds in bonds and other fixed income investments so the money can grow.
Barnett compares a fixed annuity to a bankcertificate of deposit, with a term and a set interest rate.
A fixed annuity is not that different, he said.
Variable annuities are riskier because future payments are based on the performance of underlying investments.
Funds usually go into sub-accounts and the overall return is based on how those sub-accounts perform.
Once the annuity payout phase begins, youll get your payments back plus any investment income and gains.
However, investment gains inside a variable annuity are almost always capped at a certain percentage.
Its not an unlimited upside, its always limited, Barnett said.
Variable annuities also carry the highest fees.
Like a variable annuity, gains are capped at a certain percentage.
What Are Typical Annuity Fees?
In addition to being confusing, many investment experts pan annuities because of their high and complex fee structure.
Generally, the more complicated the annuity contract, the higher the costs.
On average, annuity fees can range between 2.3% to 3% of your account balance each year.
All annuities charge commission, which is usually baked into the price.
Fixed annuities, which are relatively straightforward, tend to charge the lowest fees.
But insurance companies build heavy fees into other types of policies, like variable and indexed annuities.
Besides commissions, the annuity company will charge administration and mortality fees, among others.
What Are Surrender Charges?
Annuities are meant to achieve long-term goals, like retirement.
Because of this, the annuity principal will be tied up for a period of time.
Annuities come with surrender periods during which youre not supposed to withdraw money or cancel the contract.
Surrender periods usually last six to eight years.
What Are the Benefits of Annuities?
While high fees are a drawback, annuities can make sense for some people in certain situations.
Guaranteed Income
The biggest draw of annuities is guaranteed retirement income.
Deferred Taxes
Tax-deferred growth is another benefit of annuities.
When you take the money out, proceeds are taxed as ordinary income and not as capital gains.
What Are the Downsides of Annuities?
Leaving Money on the Table
Losing out on possible wealth accumulation is a huge downside with annuities.
Thats really going to end up reducing your wealth in the long run.
Different ethical standards
There are some ethical issues, too.
People who sell annuities usually work for an insurance company as broker dealers.
Other financial institutions including banks, brokerage firms and mutual fund companies may also sell annuities.
When you purchase an annuity, you get the option to add annuity riders to your contract.
A rider is an extra benefit or guarantee.
For example, a cost-of-living-adjustment rider guarantees that your annuity payments will gradually increase over time.
Each rider costs money, usually 0.5% to 1% of your contract.
The surrender period usually lasts six to eight years after you buy an annuity.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.
(Can you sense my millennial sarcasm there?)
You know which ones were talking about: rent, utilities, cell phone bill, insurance, groceries…
