Should You Purchase an Annuity?
Worried about your retirement savings? You have a lot of company. That's why you may have noticed even more ads about annuities--tax-deferred insurance products that pay out a regular stream of income.
But there's a dark side to annuities. They're highly complex--with a host of downsides, ranging from steep fees to early withdrawal penalties. Here's what you should understand before you buy one:
The different flavors
Annuities pay out in monthly, quarterly, or annual installments, or in a lump sum, depending on what type you choose. And they come in a few varieties.
First, they can take the form of immediate or deferred payment. With the former, you start getting a payout soon after you open the account. With deferred annuities, on the other hand, your money is invested for a certain period of time, after which you can start making withdrawals, usually after you've retired.
Those aren't the only twists. In addition, annuities can be fixed, meaning you get a payout with a guaranteed minimum interest rate that never changes - these days around 8%. Or they can be variable, in which case the income stream is determined by the performance of underlying investments. Variable annuities usually have a higher rate of return than the fixed type, but the value of the investments can decline. So, there's a tradeoff. "With a fixed annuity, you can be sure you won't lose any money," says Meg Green, a financial advisor and founder of Meg Green & Associates in North Miami Beach, Fla., www.meggreen.com. "But you have to be willing to give up some income."
Those are the basics. There are hundreds of variations and many insurers offer a long menu of options. "They come with more bells and whistles than you can imagine," says Seth Greene of Silver Spoon Financial Officers in Williamsville, NY. If, say, you buy a $100,000 annuity and it jumps to $200,000, only to drop to zero before you die, one plan might pay your spouse the highest value, while another could only give back the original amount. The upshot: Make sure you understand exactly what you're getting before you buy.
The benefits.
For one thing, you receive a lifetime income stream. What's more, your principal can be insured even after your death. "You don't get that in a mutual fund," says Green of Green & Associates. Perhaps most important, the earnings are tax-deferred. And unlike other popular vehicles like 401(k)s and IRAs, there's no annual contribution limit. As a result, you can put away more money - an especially important feature if you're close to retirement age and trying to make up for recent market losses.
The problems.
The biggest issue is those high fees. Most annuities are sold by brokers, who collect a commission of as much as 10%. With variable annuities, you'll also pay a yearly charge of 1.25% or more, plus annual management fees of .5% to 2% or greater, and fees for insurance riders, adding another .6% or so.
Then there's the matter of withdrawal penalties. Withdrawals after age 59 ½ are taxed as income, but you have to pay a 10% penalty if you take money out earlier. In addition, you face big surrender charges, which generally are around 7% of your account value if you withdraw money after the first year; the amount drops after that until year seven or so, when the charge goes to zero.
The economic crisis has created some new problems, as well. For variable annuities, there's the issue of volatility. They're invested in "sub-accounts", which can decline substantially in value if the market drops. Also, battered by the downturn, some providers of variable annuities offering a guaranteed minimum payout recently have raised fees and decreased benefits.
The long-term health of the insurer is also a consideration. You don't want to purchase an annuity from a company that's about to go out of business. For that reason, it's more important than ever to research the insurer - and to go with only top-rated firms. Another tactic: Spread the wealth. "I wouldn't put all my money in one contract with one company," says Seth Greene. "You want to diversify the risk." Keep in mind that all states guarantee coverage of at least $100,000 per insurer. So, if each annuity is under that amount, you'll be protected. And one more thing: Should you have second thoughts, you can return your annuity within 10 days. In these uncertain times, that's a nice assurance to have.
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About the Author: Anne Field is an award-winning small-business writer based in Pelham, NY
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