What’s Wrong with an Annuity?

I don’t really like annuities for most people. Let me tell you why:
First – what is an annuity? An annuity is a retirement product from an insurance company. You invest your money and, at retirement, you receive regular, continuing payments. Social Security is a type of annuity. You contribute during your entire work life, and when you retire, you get money back the rest of your life. What’s wrong with that?

More than 90% of the people who buy annuities, never “annuitize” them, never start taking the money out on a regular basis. They end up paying much higher fees and much higher taxes than if they had invested the money themselves.

Annuities invest in sub accounts which are just like mutual funds. But annuities have more fees and higher fees than mutual funds or Exchange Traded Funds. I’ve found annuities charge about 3% per year in fees. Compare that to a Mutual Fund with a 0.5% fee. Over a long period, this difference amounts to thousands, more often tens of thousands of dollars lost.

Taxes. The growth of a regular mutual fund is taxed at the lower capital gains rate; the growth in an annuity is taxed at the higher income rate. This is a big disadvantage. Also, annuities are often sold as a way to defer taxes. I believe taxes will be higher in the future. Why would you want to defer taxes to a point in the future when taxes are higher?

Annuities are a big gamble. Once you annuitize and start receiving checks, your money is no longer yours – it now belongs to the insurance company. If you don’t live very long, many of your hard earned dollars are lost to your heirs. On the other hand, if you live to be 120, you win. It’s a gamble.

Annuities are subject to unusually high levels of abuse by salesmen. Annuities have very high commissions, often 4-5%. Greedy salesmen will switch you from one annuity to another to increase their commission (this is called churning). Abuse includes putting an annuity in a retirement account.

Unless you pay extra, the payoff is fixed over time; it does not go up with inflation.

Many annuities come with a surrender fee (which protects the salesman’s commission). Bad thing – never ever buy anything with a surrender fee.

There is a 10% IRS penalty if your contributions are withdrawn before 59½.

The value of your investment is not “stepped up” to beneficiaries at death.

At some point an annuity salesman will try to sell you an annuity. My advice: buyer beware; know what you are doing when you consider buying an annuity. I spend much of my time trying to undo unwanted annuities, and it is a very difficult and time-consuming task.