When it comes to planning for your fiscal future, you can easily be bombarded with investment options, and among them are annuities. While they offer some benefits, including diverse investment options and a death benefit, there are several drawbacks to consider when determining why annuities might be a bad investment for your financial goals.
Weighing the Cost
With an annuity, you make a lump sum investment with an insurance company, either directly or through a broker, and the money is invested during an accumulation phase to be paid out at a later time, either as one large payment or as a stream of payments. The many fees associated with purchasing an annuity may cut into your return. In addition to fees and commissions you pay your broker, you may also pay additional fees associated with the investment options you choose for your annuity. For instance, if you direct some of your annuity investment for mutual funds, you may have to pay additional broker fees for the mutual funds. If you decide to make changes to how your money is allocated, transfer fees may occur. For instance, if you direct 1/3 of your money to stocks but then decide to move it to a mutual fund, you may have to pay an additional transfer fee.
Planning for your future requires a great deal of thought and a certain amount of predictability. Annuities require a long-term commitment--after all, they are generally established to create additional income when you retire. Unfortunately, you can’t foresee the unexpected and if, for some reason, you need to cash in your annuity early, you will be penalized with a surrender fee. Entrusting your financial future with one company requires a certain level of faith that the insurer will still be around when it comes time to start paying your retirement income. Some states offer funds guaranteeing annuity payouts, so check with your local government to find out what regulations apply in your area.
Always a Risk
As with any other type of investment, there are no guarantees with annuities. While you may carefully consider a host of economic variables to determine how to allocate your annuity, without a crystal ball, you just won’t know for sure. You may make a lump sum payment of $10,000 and direct it to be split up evenly between a stock fund and mutual fund. If the stock fund only has a 2.5 percent return while the mutual fund has a 10 percent return, you would have been better off directing more money to the mutual fund. As mentioned earlier, re-allocating the money will result in additional transfer fees, which cut further into your earnings. Fixed rate annuities create an even bigger risk, because of increased cost of living and inflation. If you lock in a guaranteed rate of return on your annuity, you may miss out on increased interest rates and jeopardize your chances of a maximum return.
Annuities are tax deferred, which may sound like a benefit at first. The key word, though, is “deferred” not “exempt.” Once you start receiving annuity payments, an income tax will be applied. In addition, you will have to pay a 10 percent tax penalty for receiving annuity payments (or pension payments) before the age of 59 years and 6 months.
Based in South Florida, Leann Harms has been writing since 2008. Her design, technology, business and entertainment articles have appeared in "Design Trade" magazine and Web sites including eHow. Harms has a Bachelor of Arts in English from Florida Atlantic University.