What’s good, bad, or ugly about an annuity? It depends on what you want and what kind of income you have. An annuity is a big sum of money that is spent to make a steady monthly income for a set amount of time or for life. The money can start coming in right away (instant annuity) or later (delayed annuity). The people who give out the funds do not protect or cover them. If the annuity is set or changeable, the size of the future monthly check is not always a given.
There are many different kinds of annuities. Since I don’t sell things and get paid fees, I’m suspicious of the reasons why people sell financial goods, especially successful ones like variable annuities:
People who don’t understand them are sold too many complex variable annuities. They’re so hard to understand that it’s annoying. The people who sell variable annuities get big fees, so they may be very eager to sell you one. Salespeople who get paid based on how much they sell are NOT required to put your needs before their own.
Annuities should only be bought if there are good reasons to do so and if they fit into the “whole financial picture of an individual or couple.” People who sell annuities often only care about “closing the deal” and don’t look at the buyer’s whole financial situation.
Not everyone needs or wants an annuity. If you get Social Security, you already have a set, adjusted pension that will pay you for the rest of your life. If you have a pension, you get a set amount of money every month for the rest of your life. If nothing else, the insurance part of an annuity means you “lose” if you die sooner than your peers because the insurer gives your monthly payouts to people who bought annuities after you.
So, what makes an annuity good, bad, or ugly?
If you make a lot of money and are in a high tax bracket, it might make sense to buy a low-cost variable annuity if you’ve maxed out your 401(k) and IRA contributions and expect to be in a lower tax bracket when you retire. Low-cost variable annuities have annual fees of less than 1%.
You might want to buy a low-cost fixed or variable annuity if you want to turn a big sum into a steady stream of income and you can afford to tie up a certain amount of your money for a long time (maybe forever).
“Longevity annuities” might be a good idea if you’re worried about outliving your money and can put some of it in an annuity. With a longevity annuity, you can start getting money later in life.
The government is starting new programs that will let people who have a 401(k) put some of their money into a pension. The government is worried about low 401(k) returns because owners don’t always make smart investments. The annuity choice is seen as a way to give retirement more stability and security.
Charitable annuities can be a great way to make a tax-deductible gift to a charity and get a steady stream of income for life from a part of the investment.
THE UGLY AND THE BAD:
Variable annuities can tie you down with 3% to 4% yearly fees and steep (up to 15 years or more) fines for leaving the plan early.
Are you looking at variable annuities with bells and whistles that you don’t really understand, starting with the “seems too good to be true” examples you’re being shown? If so, I think you should get a second view from someone who has nothing to gain from the pension.
Do you pay a low or average amount of tax? If you buy an annuity with after-tax money to avoid investment income, you may be disappointed if your income tax bracket stays the same or goes up in retirement because you take out a lot of RMDs from an IRA or 401(k) and tax rates are likely to go up even more in the future.
Also, if you buy an annuity with money that you already paid taxes on, it may not be the best tax move. You will switch from lower tax rates on capital gains on taxable income to higher tax rates on ordinary income on all contract gains.
If you want to put off getting money, you don’t need an annuity in your IRA because the IRA itself lets you put off paying taxes. Holding an annuity in an IRA is mostly a waste of time unless you want the insurance or death payout.
A set annuity could be a good addition to your general financial and investment plan, but interest rates are very low right now. You would be better off getting a set annuity that locks in higher interest rates when interest rates are high.
Your money might be gone for good. After-tax annuities can’t be taken back. Once the money is in an annuity arrangement, it stays there. If you no longer have yield fees, you can roll over a bad or ugly annuity into a cheaper one if you need to or want to get out of it. You can’t end the pension system, though.
Do you want to leave your flexible income to your children or grandchildren? When the original owner (the annuitant) dies, there is no step-up in base to the position’s date-of-death value. This means that the annuity is not a good gift.
In short, when interest rates go up, some people might be interested in set annuities.