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Five Reasons Not to Invest in an Annuity… and 5 Reasons You May Want To


You may have gone to a seminar dinner where you were given an annuity sales pitch. And the sales pitch made annuities sound like the best thing in the world, and that everyone needs to buy one.

But the reality is, an annuity is not right for everybody.  For some people they are very good products designed to help them plan for their retirement. For other people there’s just not a need for that based on the person’s circumstances.

And what happens a lot of times is that people buy an annuity when they don’t really need one. And they may buy one for the oddest of reasons. Unfortunately sometimes these reasons can be because a certain type of advertising or marketing led them to believe something that wasn’t true.

So here are five reasons not to invest in an annuity. And after these we’ll get to the five reasons why you may want to invest in an annuity.

#1: You want to get 100% market upside growth with no downside loss potential

This would be the Holy Grail of investing. Imagine if you could always make 100% of the market’s increase but never lose money when it goes down.

But you know this is too good to be true. There’s no way that you can get all of the growth of a market without also exposing yourself to the potential that you could lose money as well

However, fixed index annuities are often portrayed to the public in this light. It’s the dream that you’re going to get all market growth with no downside potential loss.

And while it’s true that there is no downside potential loss, it also needs to be clearly understood that you’re not going to get 100% of all the upside on the market.  Fixed index annuities limit your upside, and they do this with things called cap rates, spreads, and participation rates.

And there’s nothing wrong with that as long as you understand what the benefit of a fixed index annuity and not have any false notions planted in your head that you’re going to get 100% market growth out of one.

#2: You want to keep your money liquid

Most annuities have surrender charges. And these can range from 3 years to beyond 15 years.  Again, there’s nothing wrong with that. If you set aside money for a certain benefit you need, and the annuity provides that benefit, then it may make sense in your situation to commit your funds for a longer period.

And most annuities do give you some liquidity options such as 10% free withdrawals or the ability to withdraw your interest. Many will also have other options to get income out of them through annuitization, as well as activating an income rider that can guarantee you lifetime income.

But if you need your funds to be liquid and you think you might have to withdrawal all of them in a short time frame while they’re still in a surrender charge period, you’ll want to avoid putting those funds into an annuity that would cause you to pay a surrender charge.

The exception to this would be no-load variable annuities. In many cases they have no surrender charges whatsoever… from day one. They’re just used to put a tax deferral shell around your non-qualified money that you invest.

#3: You want to get 8% guaranteed interest on your money

Unfortunately, another common marketing effort in annuities nowadays is to advertise really high interest rates as if your money is growing at this specific interest rate.

I’ve written about this a decent amount in the past but it bears repeating again.

When you see an interest rate appears to be too good to be true, then it probably is.

Nine times out 10, that very high guaranteed interest rate is not the amount your actual money will grow at. Instead, that high rate typically applies to a phantom account called an Income Account. And that Income Account is used simply as an accounting figure to determine how much guaranteed income the insurance company will pay you for the rest of your life under the income rider.

#4: You want additional tax deferral on your IRA

IRAs are a great way to have tax-deferred growth on your money. And you don’t pay taxes on it until you pull the money out of the IRA.

And annuities work the same way. As long as the money stays inside the annuity the earnings grows tax-deferred, even your non-qualified (i.e. non-IRA funds) earnings.

But you won’t get any additional tax deferral on your annuity by using IRA funds inside it. That doesn’t mean it’s a bad thing to put IRA funds inside an annuity. In many cases that may make sense for your situation. But you won’t get any extra tax deferral benefit for doing so.

So if you’re putting IRA funds into an annuity, make sure that you’re doing it for other benefits than additional tax-deferral. These other benefits may be guaranteed income, protection of your principal from market losses, or some other benefit that annuities are very good at providing. This may also include helping increase the legacy you leave your heirs, or even helping for some long-term care expenses.

 #5: You want to trade frequently

When you put money into an annuity, you’re putting your money in the hands of other people to manage it.

In the case of most variable annuities, you have limited choices of money managers that you can allocate your funds across in the sub-accounts. And you can change the allocations at different times, but they will be managed by other money managers

There’s nothing wrong with that, by the way, just as long as you understand that up front.

And when it comes to fixed index annuities you allocate your funds across different indexing options. Usually these different options are committed for at least one year. So if you like to trade your funds frequently then an annuity is probably not going to be the best option for you.

Now here are five reasons why you may want to invest in an annuity.

#1: You want SOME market upside with no downside potential

The fixed index annuity’s benefit is that it can offer some of the market upside by tracking an index. And it has no downside loss potential if the market crashes. This is one of the best value propositions of a fixed index annuity.

Your upside potential is going to be limited based on cap rates, spreads, or participation rates. But the benefit of not having any of your money at risk of market losses is a big benefit for a lot of people planning for retirement.

Keep in mind fixed index annuities are conservative investments. Therefore you can’t expect to have market like returns over the long term with a fixed index annuity. They were originally designed to compete with CD returns.

And as long as you keep that in mind it’s going to go a long way to keep you from being disappointed with their returns that they may give you.

#2: You don’t mind committing your funds long-term

As I was saying earlier, most annuities will have a surrender charge period. This can range from 3 years to beyond 15 years.

With a proper strategy in place this may make sense for your retirement planning. It’s not necessarily wrong to commit your money for that long, as long as it’s serving a purpose and it’s helping you to achieve your goals.

Some of the longer-term annuities can provide good benefits such as strong income guarantees.  If that is a benefit that you need for your own retirement goals, then it may make sense for you to commit your money for the longer-term.

#3: You want a guaranteed interest rate

Some annuities will lock in an interest rate and guarantee you that rate for a certain period of time. These are called Multi Year Guaranteed Annuities. In many cases they will guarantee a rate that’s higher than current CD rates.

They have no market risk. Whatever rate they guarantee you that is what you would get for the term of the contract. These can be as short as 3 years. A very popular option is a 5-year rate guarantee.

#4: You want to leave more money to your heirs

Life insurance is still the best way to leave money as an inheritance to your heirs. It pays out tax-free to them and avoids probate.

But not everybody is healthy enough to qualify for life insurance. And that’s where annuities can offer another option.

Some annuities allow you to attach, for a fee, a death benefit rider that’s guaranteed to increase the death benefit of your annuity. This may be a good option for the funds that you want to pass on to your heirs that you don’t need to spend on yourself.

But if you can qualify for life insurance, go that route.

#5: You want a money manager to handle your investments

When you invest in an annuity you are not going to be actively managing your funds. With a variable annuity it’s going to be managed in various sub-accounts with different money managers that you can choose based on your goals and risk tolerance.

With a fixed index annuity you choose the index option that you want and it’s typically locked in for a year. The insurance company takes care of the rest.

There is absolutely nothing wrong with wanting somebody else to handle your investments. And investing in annuities is one way to accomplish this.

Conclusion

Hope that helps you to understand some of the reasons why you should not invest in an annuity as well as some reasons why it may be beneficial based on your unique situation.

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Warmest regards

Chris Hammond

Invest in an annuity


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Investment Advisory Services offered through Retirement Wealth Advisors, (RWA) a Registered Investment Advisor.  Tri-State Financial Group, and Tri-State Insurance & Financial Services, and RWA are not affiliated. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.

This information is designed to provide general information on the subjects covered. Pursuant to IRS Circular 230, it is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Tri-State Financial Group and its affiliates do not give legal or tax advice. You are encouraged to consult your tax advisor or attorney.

Annuity guarantees rely on the financial strength and claims-paying ability of the issuing insurer. Any comments regarding safe and secure investments, and guaranteed income streams refer only to fixed insurance products. They do not refer, in any way to securities or investment advisory products. Fixed Insurance and Annuity product guarantees are subject to the claims‐paying ability of the issuing company and are not offered by Retirement Wealth Advisors. Chris Hammond is insurance licensed in TN.