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debunking annuity myths

Debunking Annuity Myths

Categories: Annuity Education, General Interest

Planning for retirement is an involved process that can be stressful. Annuities, which are a popular way of planning for your retirement, are often misunderstood. Though not complicated in practice, there is a lot of nuance when it comes to setting up an annuity, hence the misunderstandings. In this article, we aim to set the record straight and give you what you need to know in order to decide if an annuity is the right move to make for your golden years.

Annuity Myths – And Truths

Annuities are structured as a contract between you and an insurance company. To fund the annuity, you can choose to make a lump sum payment or make smaller periodic payments. As financial instruments go, this is a pretty simple arrangement.

Yet, they still involve a number of moving parts, and inaccurate perceptions about them abound. Let’s walk through some of these errors and offer correctives based on our decades of experience working with annuities.

An Annuity is Unnecessary if I Already Have an Individual Retirement Account

It’s natural to compare an annuity to an individual retirement account (IRA), as they do have many similarities. Both are popular methods for saving for your retirement, and both have a number of tax advantages, etc. But they’re not the same thing. An IRA doesn’t replace an annuity or vice-versa.

For starters, an individual retirement account is an account. It’s not an asset on its own; it’s a way of storing assets like shares of a mutual fund or stocks. IRAs are pretty flexible, and once you’ve deposited your chosen assets into an IRA, they can grow tax-sheltered.

Annuities are a different kind of product. Most annuities are designed to pay you guaranteed retirement income in the future, but immediate annuities derive their name from the fact that their payouts begin in less than a year.

If you’ve fully funded your IRA and want to save additional money for your future needs, using both an IRA and a non-qualified annuity could be a robust strategy for retirement planning, and in most circumstances, you will receive tax advantaged income from your annuity payouts if structured properly.

This approach won’t be for everyone, of course, but our point here is that both IRAs and annuities can be great ways of investing for your retirement, and owning one doesn’t mean you shouldn’t think carefully about owning the other.

An Annuity Has Some Similarities to Life Insurance

As with IRAs, it’s also natural to wonder about the overlap between annuities and life insurance. Annuities, after all, are insurance products, and like life insurance, annuities can be structured such that they offer financial security for a spouse or other family members after you pass away.

Still, there are major differences between annuities and life insurance. Perhaps the biggest is that they’re aimed at achieving completely different objectives. A life insurance policy exists only to pay out to surviving loved ones when you die. There are annuities — like joint life annuities — which can do this too, but the chief purpose of an annuity is to pay you while you’re still alive and enjoying your retirement.

Annuity Income Stops When I Die

On a related note, there’s also a common myth that annuity payments stop once you die. This stems from the fact that there are different kinds of annuities that have different payment schedules, some of which cease after a certain period of time, some of which cease at your death, and some of which carry on after death.

Period-certain annuities stipulate that payments will be made over a certain interval of time, usually between 10 and 20 years, and will stop after that point. After your death, any unpaid portion of payments remaining will continue to your named beneficiary.

Joint life annuities, on the other hand, pay a certain amount each month, as long as either you or the joint annuitant (like your spouse) are living.

Deferred fixed-rate annuities are designed to be accumulation vehicles prior to the activation of income and typically guarantee a fixed interest rate for a period of 2 to 10 years. If you were to die while owing this type of annuity, the account value would pass to your named beneficiaries.

Annuities Are Expensive to Own and Have Lots of Fees

Another myth is that annuities have high fees. Typically, when someone makes this statement they are referring to variable annuities, which in some cases, do have elevated fee structures.

However, fixed annuity products, the kind AnnuityAdvantage sells, typically do not have any direct policyholder fees. An exception to this rule is if an optional enhanced benefit or income rider is added to a deferred annuity contract at the owner’s request.

The only other time a fee would apply to a fixed deferred annuity is if the contract was surrendered or a withdrawal was made exceeding the penalty free withdrawal provisions during the time in which the contract is still subject to early surrender penalties.

Annuities Only Make Sense for Retirement Planning

In our writings on annuities, we’ve generally framed them as vehicles for planning for your retirement. That’s often how they’re used and discussed, so this framing makes sense.

That does not, however, mean that annuities only make sense in that context. Fixed annuities can also be used as part of a broader saving and investment strategy, especially for those seeking to avoid risk and market volatility.

Take fixed-rate annuities as an example. Unlike immediate income annuities — which involve funding the annuity in exchange for guaranteed payments for life — a fixed-rate annuity looks a lot more like a certificate of deposit (CD) that you’d get from a bank. You deposit your money and earn a set guaranteed interest rate for a certain period, usually on the order of 2 to 10 years. Even if you’re 40 and not particularly worried about retirement just yet, such an arrangement would almost certainly outperform parking that money in a standard savings account or money market. It may not outperform a more sophisticated strategy of investing directly in the market over a longer period of time, but that’s notoriously hard to do well, and one wrong move or poor market timing decision could result in significant losses.

For this reason, annuities can also be sensible for younger people who are looking to grow their wealth. But bear in mind, withdrawals of interest earnings prior to the age of 59 1/2 will incur a 10% IRS penalty.

Annuities are Confusing

The final myth we’ll tackle is the idea that annuities are confusing. There’s no denying the fact that finance as a whole can be confusing. Whether you’re talking about the ins and outs of the bond market or cutting-edge algorithmic trading strategies, finance is a domain that can have a lot of complexity.

Annuities are reasonably simple as finance goes, as they mostly boil down to buying a contract that is designed to accomplish one of three primary goals; a) grow your money, b) get income now, or c) guarantee future income.

Guaranteeing future income is how deferred income annuities or longevity annuities work. The difference between these annuities and immediate annuities is that the latter must start paying out within 12 months after the contract is purchased.

Fixed-rate annuities work a little differently, more like a certificate of deposit or a bond, but this, too, isn’t hard to work through.

On the whole, if you’re looking to save, invest, or plan for your retirement, it’s hard to find anything simpler than an annuity, once you have taken the time to acquire a basic understanding.

Getting Clear on Annuities

In the final section above, we argued that annuities are simple financial instruments. But if you still have questions, feel free to reach out to one of the annuity specialists at AnnuityAdvantage. Let us put our industry-leading experience to work for you, and we’ll help make the implementation of your retirement strategy a breeze.