Is An Annuity Right For You?

by | Jun 7, 2021 | Wealth Management

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By: Arash Navi, CFP®, CPA

It is estimated that half of all children born today in the United States and Europe will reach their Centennial birthday. The number of Americans living past their 90th birthday will triple in the next 30 years. Consequently, it makes sense that the number one worry of retirees is running out of money!

Unlike previous generations, many employers don’t offer traditional pensions and Social Security payments are estimated to equal only about 40% of pre-retirement income. There is also the uncertainty around whether or not Social Security will be available decades from now. So, it is natural that many people are looking for other “guaranteed” sources of income to supplement their retirement needs. This is where annuities come in to play.

What is an annuity?

An annuity is a long-term financial contract between an insurance company and an annuity owner whereby the insurance company guarantees a stream of future payments in exchange for an investment now.

Different types of annuities?

Immediate Annuity If you choose an immediate annuity, you typically begin to receive your stream of income shortly after your initial investment. Individuals nearing retirement tend to consider this option as a supplemental income to Social Security.

Deferred Annuity This type of annuity is structured to help investors accumulate capital over their working life and defer taxes on those earnings during that period. It offers the ability to turn these assets into a stream of income at retirement or later in life.

  • Fixed Annuity – A fixed annuity provides a guaranteed amount during the payout period with relatively low risk. For older contracts, the rate of return may be around 3% or more but new contracts are often under 1%.
  • Variable Annuity – A variable annuity provides a return that is generally tied to a performance of a portfolio of mutual funds that the annuity holder chooses. You carry the investment risk and have the potential to make or lose money. Often, they offer a guaranteed minimum rate of return but at the same time may cap the maximum amount of return as well.
  • Indexed Annuity – An indexed annuity is similar to a variable annuity, but the rate of return is tied to the performance of a stock index such as S&P 500. Therefore, you can benefit if the stock market is performing well. Depending on the insurance provider, your investment may be subject to a minimum and maximum rate of return.

Advantages of annuities?

The main advantage of annuities is that it allows you to defer incomes taxes on the earnings from your annuity investments until you begin receiving your stream of income. Also, there is no annual contribution limits, so an individual is able to put away more money for retirement. This may be particularly appealing to investors who have maxed out their annual 401(K) and IRA contributions and/or are nearing retirement. Another benefit is that you are not subject to mandatory withdrawals (unless the annuity is qualified – like a retirement account) at a certain age and have the flexibility to choose how you’d like to receive your payments. Finally, annuities’ insurance feature can be a great estate planning tool. The death benefits to the beneficiaries in most cases will not be subject to probate and estate taxes.

Disadvantages of annuities?

The main disadvantage of annuities are the fees involved. A typical annuity is sold by an insurance broker who makes hefty commissions on it. In addition, annuities are subject to surrender charges which means if you change your mind and decide to withdrawal your investment earlier than planned, you will have to pay a penalty (most annuities allow you to withdrawal 10% of the contract value per year without penalty). Depending on the type of annuity you choose, you may face high annual fees (and even higher if there are any rider guarantees) which will further erode the rate of return on your investment. Variable annuities typically have higher fees since the potential growth is uncapped and you have the underlying mutual fund fees. Finally, keep in mind that once you began receiving your payments, the annuity gains are taxed as ordinary income versus long term capital gains which may be less beneficial for wealthy investors.

Final thoughts

There are many factors to consider when deciding to purchase an annuity and it is important to discuss your specific financial situation with an advisor to help you make the right decision that best meets your needs. An annuity may not be suitable for a typical investor due to its illiquidity, high fees, surrender charges and low rates of return. However, the possibility of higher estate taxes and longer life expectancy could make this an appropriate retirement and an estate planning tool for some.

Recently, BFSG’s Senior Financial Planner, Paul Horn, CFP®, CPWA®, was invited to be a guest speaker for the “It’s Your Money!” workshop series put on by not-for-profit Financial & Estate Literacy. Learn more about annuities by clicking HERE. Feel free to reach out to us if you’d like to learn more!

Additional Sources:,you%20will%20get%20each%20month.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

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