6 Reasons You Shouldn’t Buy an Annuity – What Insurance Companies Don’t Want You to Know

When considering your finances for later in life, it’s important to understand your options. One common retirement planning tool, the annuity, provides financial protection by exchanging present contributions for future income. It’s a unique solution aimed at those concerned about outliving their retirement savings – but it’s not the perfect fit for everyone. In fact, there are some compelling reasons that might make you reconsider buying an annuity. Here are 6 reasons why an annuity for retirement might not be your best choice:

1. Annuities Are Not Government-Insured

Annuities are primarily issued by insurance companies, although they can be purchased through various channels such as banks, brokerage firms, and financial advisors. Despite being available for purchase through these institutions, annuities are ultimately sold by life insurance companies.

Contrary to a common misconception, the money you invest in an annuity is not insured by the Federal Deposit Insurance Corporation (FDIC) like bank deposits are. This is because the FDIC insures deposit accounts at insured banks and savings associations, but it does not insure products, even if they were purchased from an insured bank.

In terms of risk, if the insurance company that holds your policy goes under, your investment could indeed be in jeopardy. However, it’s worth noting that each state has a guaranty association that provides a safety net for policyholders if an insurance company fails. The extent of this protection varies by state and by the type of insurance coverage.

2. You’re Already a Successful Self-Investor

If you’re someone who has had consistent success in managing your own investment portfolio, and you have a firm grasp of financial markets, an annuity may not be the most beneficial choice for you. The returns are often modest and are generally considered safe and low-risk. Annuities are primarily designed to provide a steady stream of income during retirement. So, if you’ve been successful with your own investments, it’s likely because you’ve already developed a strategy that suits your specific risk tolerance and goals. You might be comfortable with higher-risk investments that can potentially offer higher returns. Not to mention, if you’re a moolah-savvy person, you’ll know that managing your own investments allows for greater flexibility. You can adjust your strategy based on market conditions, personal financial changes, or shifts in your long-term goals; and, annuities are typically restrictive with high surrender charges for early withdrawal.

3. Annuities Can Be Complicated

Indeed, the world of annuities is vast and diverse, with many types to choose from, each with its unique characteristics and benefits. Annuity contracts can be intricate and potentially confusing due to their unique features and provisions. For instance, some annuities may have surrender charges for early withdrawal, while others might offer various riders for additional costs. Since they can be so complex, some retirement planners may find themselves purchasing an annuity that isn’t the best fit for their financial situation or goals.

For a basic understanding of how annuities work, check out the infographic here.

4. Unrealistic Return Expectations

Annuities are not traditionally designed for high returns but rather for steady, predictable income over a certain period. If you’re expecting a high return from your investment, an annuity might not meet your financial expectations. If you are someone who is seeking high returns, then you might be better off exploring other investment vehicles like stocks or mutual funds, which traditionally have the potential for higher yields (albeit with higher risk).

5. High Fees

Before buying an annuity, you should be aware of potential fees that can affect your total cost and reduce the payout. Administrative fees, subaccount fees, and principal protection are just a few fees to know about when buying an annuity. Many fees are unique to specific annuity types, while others, like mortality and expense fees, are always included.

6. Liquidation Needs

If you anticipate needing early access to the funds you’ve invested in an annuity, you should understand the potential repercussions, as this could lead to substantial penalties.

Most annuities have a surrender period, which is a set number of years during which you’ll have to pay a surrender charge if you withdraw more than a certain percentage of the contract value. The surrender charge is often a percentage of the amount withdrawn and decreases over time. For instance, a seven-year surrender schedule might start with a 7% charge in the first year, decreasing by 1% each year until it reaches zero.

In addition to surrender charges, if you make withdrawals before the age of 59½, you may also be subject to a 10% federal income tax penalty on earnings. This is similar to the early withdrawal penalty for other tax-deferred retirement accounts like 401(k)s and traditional IRAs.

And, finally – though it probably goes without saying, early withdrawals can significantly reduce the value of your annuity, which basically undermines the primary purpose of having one in the first place (providing a stable income during retirement). This reduction not only includes the amount withdrawn but also the loss of any potential growth on that amount.