For some people, the road to a comfortable and secure retirement leads them toward annuities. These insurance products are heavily marketed for very attractive financial bells and whistles, such as income for life and protection from market declines. But, just as Dorothy and her companions pulled back the curtain on the Wizard of Oz, annuities are not always what they appear to be when you look a little closer.
Behind the veneer of enticing promises are often secrets buried in fine print. Here are some features common among annuities that you should know about before buying one.
Annuity guarantees are not free
Though insurance companies can provide valuable services, they are in business to make a profit. So, it’s worth remembering that most attractive features, such as lifelong payments and death benefits, come with an added cost. These “riders” increase the total cost of an annuity while reducing your return. Essentially, the annual cost you pay for each rider finances the guarantee of that rider. There is no free lunch.
Insurance brokers earn commissions
For some individuals, buying an annuity makes a lot of sense. But, if you’ve been told that by an insurance broker, get a second opinion. The fact is brokers earn a commission on each annuity they sell. Commissions can be as high as 10% or more, depending on the product. While this isn’t proof that all brokers are motivated by self-interest, it is proof that there is a conflict of interest.
Withdrawing your money early will cost you
Surrender charges are fees that are incurred when you withdraw money before a specified period of time (surrender period) after you buy it, usually seven to nine years. Often, they start around 6-8%, but can be as high as 15%. They then gradually decline to zero. These fees cover the insurer for the commission paid to the broker. Your principal is protected only if you hold the annuity through the surrender period. If you need money for an emergency, you may have to pay hefty charges to access your money.
Insurance companies can dissolve – along with your annuity
The quality of an annuity depends on the solvency of the insurance company. Guarantees in an annuity are only as good as the ability of the insurance company to meet them. There is a risk that future contract guarantees might not be paid if the insurer becomes insolvent. Unlike your bank account, there is no FDIC insurance on your contract. In addition to carefully looking at the terms of an annuity, research the financial stability and bond ratings of the company underwriting it.
Annuity gains are taxed as ordinary income
Any long-term capital gains from the investments in an annuity are taxed at your ordinary income rate when you withdraw them. That means high earners will pay higher rates than the more favorable long-term capital gains rate applied to a traditional investment account like an IRA.
In the pursuit of financial security and confidence, people can often overlook the fact that they’ve had what they needed all along. Investors can receive the same benefits provided by an annuity through other financial products that are more appropriate for their financial needs and goals. Therefore, when considering an annuity, be sure you understand its various features and ask many questions about whether an annuity is right for you.
Income for Life? Sounds Good, but Do Your Homework
Learn more about annuities by downloading our easy-to-understand guide: Is an Annuity Right for You? What to Know Before You Buy. CLICK THE BUTTON BELOW. You’ll learn how annuities really work and gain a deeper understanding of three of the most common types: Fixed Annuities, Variable Annuities and Equity-Indexed Annuities.