While annuities can be a part of some financial plans, in most cases, better options are available for our clients. We carefully evaluate each situation to determine if an annuity truly aligns with their retirement goals. Often, we encounter new clients who come to us with annuities as part of their financial plans. While occasionally it makes sense, the vast majority of the time, we start calculating what it will cost to surrender the contract. Recognizing that annuities infrequently have their place in a well-thought-out financial plan, we’re just not big fans.
Four good reasons against buying an annuity:
- Annuities are challenging to understand
Annuities are not homogenous animals and can be quite complex and difficult to understand. There are many different types and contract terms, such as immediate fixed annuities, variable annuities, deferred annuities, and indexed annuities, each with unique contract terms. These complexities are detailed in the paperwork you complete upon purchase, but unless you have legal expertise, you may find it challenging to comprehend all the terms. This complexity often leads to misunderstandings and potential financial pitfalls. - Annuities can carry high costs
There are a host of fees and expenses with annuities, including administrative fees and mortality and expense fees that can add up to well over 1% just to have a fairly plain annuity. Suppose you want all the bells and whistles, including the potential for stock-market-like returns with downside protection. In that case, you will have to pay for additional riders, often bringing total costs north of 3%. Those substantial costs all erode your long-term return potential. - Hidden costs- Annuity surrender charges, penalties, expense ratios
There can also be other hidden costs with annuities, particularly if you ultimately change your mind and want to get out of an annuity. There are usually surrender charges that can run as high as 7% of the purchase price if you decide to sell within seven years of the initial purchase. The IRS can also levy penalties if you sell out before you turn age 59 ½. These costs are quite significant, so it is best to be absolutely certain before entering into an annuity contract. - Tax Inefficiencies & Consequences of Annuities
The most significant detriment to annuities, at least from our perspective, is that they are tax inefficient. That may sound odd since annuities are often sold with the promise of lower tax bills. However, in the long run, we find the downsides to the tax treatment of annuities too onerous to accept. The most problematic is that gains on annuities are treated as ordinary income, and they do not qualify for stepped-up basis upon death. That means someone will pay tax on your annuity, either you or your heirs, and you’ll probably pay at a higher rate than you would on a more traditional investment portfolio. Tax treatment must be considered before purchasing an annuity, and spoiler alert: the math rarely works.
There’s an old adage among skeptics that annuities aren’t bought, they’re sold. That means aggressive insurance or investment salespeople push the products, often on unsophisticated buyers, with the promise of guaranteed lifetime income. While that may not be an outright lie, there are many more details to consider before plopping down a chunk of your retirement savings into an investment vehicle that can be difficult and expensive to unwind. While buying annuities may seem attractive due to promises of guaranteed income, it’s essential to consider their downsides carefully. High-net-worth investors typically don’t require the “benefits” that annuities offer, as they generally have sufficient funds to sustain their lifestyles without incurring significant costs and taxes for unnecessary guarantees.
Our firm prioritizes transparency and personalized financial planning to ensure our clients make informed decisions aligned with their long-term goals. If you’re considering an annuity or any other financial product, we encourage you to consult with a trusted financial advisor to explore all your options and choose the best path for your retirement.