Annuities are an investment (and insurance product) very much unlike any other. They definitely offer some features that other investments do not, and can have a place in many people’s financial plans (see 5 Reasons to Consider Annuities). However, they do have drawbacks. Because of their drawbacks, you may decide to pass on annuities, or at least keep them as a smaller portion of your financial picture for any number of the following reasons.
1. Annuities Typically Come With Higher Fees
One thing that is becoming increasingly clear in the investment world is that fees are the number one predictor of an investment’s performance. Fees play such an important role in investment performance because they can take an outsize bite out of your returns.
Not all annuities are created equal, however. As with any investment, understand the terms. Although annuities certainly have the reputation for exorbitant fees, some annuities now have fees more in line with more traditional investments. Also, some annuities only charge you fees if you cash out or sell the annuity- something that won’t be an issue if you purchase a lifetime annuity. So depending on the annuity you get, fees may or may not be a sticking point.
2. Annuities Offer Less of a Return than the Stock Market
No company has been able to beat the stock market consistently and reliably on a large scale. Annuities are no different. When you buy an annuity, the underwriting company takes the money and invests it elsewhere, often in the stock market, factoring in a profit for themselves. This follows the risk-reward rule. The more risk you take on, the more reward or return potential you have. Since annuities remove or reduce investment risk, you logically receive less return.
3. You Aren’t Worried about Outliving Your Money
One of the biggest reasons for buying an annuity is to guarantee that you won’t outlive your money. A lifetime payout guarantee gives you a set monthly payout for as long as you live. However, if your retirement savings are large enough, you may have enough to draw down until you’re as old as Methuselah. Even better, you might be only living off your investments’ dividends, leaving the principle untouched.
4. You Want to Maximize The Money You Leave to Heirs
To get the most bang for your buck on a lifetime annuity, you surrender the entire value of your investment when you die. Of course, you can hedge your bets and take out life insurance and an annuity, or you can set aside some money that you don’t touch. But if you wanted to maximize the inheritance you left behind, annuities might not be a good option. However, be careful that you don’t jeopardize your own retirement in the name of leaving behind a legacy.
5. You Can Stomach Stock Market Drops, and Stay Invested Through the Rebound
The other popular reason for annuities is their principal guarantees. Several annuities will track the stock market but offer a guarantee that you will never lose money in a given year. So if the stock market gains, you gain too. But if the stock market drops, your investment doesn’t move. But the flip side is that your gains are also capped- typically around 7%. Since the stock market is so volatile, sometimes yielding well into double digit returns, this means that you sacrifice a lot of upside. Historically, the stock market has averaged between 7 and 12%, depending on how far back you look and what indexes you’re looking at. If an annuity caps your gains at 7%, you’ll likely end up seeing returns closer to 4%. Having said that, only invest in the stock market if you can stay invested through the ugly drops and crashes. Selling in the middle of a crash only locks in your losses.
While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.