You may have learned about the trouble with annuities. In its simplest form, an annuity is an arrangement in which you give an insurance company a lump sum of money and in exchange you receive payments over time. For a fee, that is. At the end of the day, what you’re really doing is giving up control over your money to some investment board that promises to pay you back over time. Assuming, of course, that it stays solvent.
When you enter an annuity contract, liquidity can become an issue. I hope you don’t need the money right away, because it becomes costly to withdraw in an emergency. Investors can be hit with steep penalties for early withdrawals above the contracted amount. And if you opt for a death benefit, don’t forget it’s not free. For that matter, all the bells and whistles that sound like a good idea often come with added surcharges that add up to a hefty fee.
One selling point used for annuities is their tax-deferred growth. But don’t forget that investment gains in an annuity portfolio or sub-account are taxed at your ordinary income rate, not the lower capital gains rate. And it makes little sense to invest your IRA money in annuities since that money is already tax-deferred. It’s always good practice to review your tax-related concerns with your accountant before you jump in head first.
Let’s not forget your purchasing power over a 20-year period. There’s a good chance inflation will eat away at your annuity payments. Consider this: $60,000 in income in 2010 isn’t the same $60,000 in 2030 when it’s up against a 3% inflation headwind. According to Global Financial Data, Inc., that $60,000 will only buy you $32,243 worth of goods and services in today’s dollars. Inflation, without an inflation-indexed option, could destroy your annuity payment’s buying power. But if you opt for the inflation index option, it usually comes with—you guessed it—an added fee.
So make sure you do your homework before buying an annuity. Once you get through the hundreds of pages of small print, you may discover they’re not worth your trouble. The good news is it won’t be too late.