It can be difficult to find straightforward advice about annuities because everyone has an ax to grind. Mutual funds, stocks and bonds are all direct competitors to annuities in most market niches, so anyone who sells them is innately prejudiced against annuities. Annuities are sold by insurance agents or brokers who are equally prejudiced in favor of annuities. For most buyers, it's better to learn the common objections to annuities and decide whether they apply to your own situation.
I Can't Take Out My Money
One common objection to annuities is that they're not liquid. This means that once you've put your money in, it can be difficult or costly to get your investment back out. The company issuing your annuity usually specifies a period of seven or eight years at the beginning of your contract when withdrawing funds from the annuity will trigger surrender fees. These can be painfully high at first and then dwindle with each passing year. Mutual funds with a back-end sales load work in much the same way. Certificates of deposit and savings bonds are similarly restricted but pay much lower returns.
Management Fees Are Too High
As with mutual funds, annuities have management costs that can eat into your returns over time. Not only do annuities have investments to oversee, but they also must pay for an insurance component. Annuities use life insurance data to project how long they'll need to pay you a retirement income, and that's an underwriting expense that needs to be paid. If you own a variable annuity and invest it in mutual funds, those funds also charge fees. In practice, competitive, low-cost annuities compare closely to mutual funds in their management expenses. Optional features can drive those costs up, so be sure you really need any extras before you agree to them.
Returns Are Too Low
A charge commonly leveled at annuities by sellers of rival products is that their returns are lower than you could get in more conventional products. Fixed annuities generate lower returns than bonds, while variable or indexed annuities' fees can make them less profitable than a comparable investment in mutual funds. There is certainly an element of truth to this; however, risk and reward are inextricably linked in the investment world. Bond prices fluctuate, while annuities offer hard and fast guarantees. Variable annuities can return less profit than mutual funds, but most offer a guaranteed minimum return even if the bottom falls out of the market. Mutual funds do not.
Modest Retirement Income
Upon retirement, if you draw your income from IRAs, you can take as much or as little as you choose down to the legal minimum. With an annuity, the insurance company determines how large an income you'll get from the accumulated investment, and the payments sometimes seem low in relation to the amount of capital involved. However, those payments are guaranteed even if you live 20 years longer than expected. With conventional retirement planning, you'd either outlive your money or need to reduce your standard of living. Often, the best solution is to combine investments, using annuities to provide a guaranteed income and other products to create larger returns.
What Happens at Death
Traditionally, if you started taking an income from your annuity in February and died in October, the balance of your annuity would go to the insurance company to help offset the costs of longer-lived clients. Modern annuity products offer several ways around this. You can have payments continue to your heirs for a set time, pay out the balance to a beneficiary without probate or have payments continue to a named second person for his lifetime. These options all carry a cost and often reduce the amount of your income, but they can transform annuities into a valuable estate-planning tool.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.