Advantages and Disadvantages of Annuities: Why Investors Aren't Excited About Annuities in Retirement
In a changing economic landscape, pre-retirees and retirees alike are understandably anxious about their best options for a secure and comfortable retirement. Some of the market volatility we’ve experienced in the past few years may well be a temporary disruption. But other changes, such as inflation and the uncertain future of Social Security, may have longer-lasting consequences.
While many investors have historically been less-than-enthused about annuities, it’s worth learning more about the advantages and disadvantages of annuities to see if it’s an option you’d like to keep on the table. After all, changing economies make it more important than ever to reevaluate different choices for the best future outcomes.
Advantages of Annuities in Retirement
Even though experts are divided on whether annuities belong in a sound financial plan, there are advantages to annuities that can make them attractive to investors. Some of these advantages include the fact that annuities:
Provide a guaranteed income stream
Are customizable
Mitigate longevity risk
Guaranteed Income Stream
The greatest advantage of an annuity begins with three little words that, we have to admit, sound pretty nice: guaranteed income stream. This is the main appeal of the annuity. Investors who prefer consistent monthly payments over fluctuating budgets and reliability over volatility may purchase an annuity for precisely this reason.
Income can begin almost right away if you purchase an immediate payment annuity. An immediate payment annuity is essentially what it sounds like: once purchased, this type of annuity starts providing an income stream almost at once. Keep in mind that most immediate payment annuities don’t allow you to cancel the contract for a refund—once you have one, you have it for life.
The alternative to an immediate payment annuity is called a deferred annuity. A deferred annuity contract outlines an accumulation phase during which the annuitant pays into account for a period of time. The accumulation phase ends when the annuitant elects to start receiving income, which begins the payout phase. The longer the accumulation phase, the bigger the payments.
Both immediate payment annuities and deferred annuities are typically available as fixed annuities, variable annuities, and indexed annuities.
Customizability
Despite their reputation for rigidity, annuity plans offer a rather large degree of customization possibilities depending on your wishes and financial circumstances. Although you typically can’t cancel many types of annuity contracts, you may be able to add various terms or riders to the contract to meet your specific needs.
Many annuities allow you to customize the contract by adjusting the payment periods and setting a duration for the payment of the income. You can even add a spouse or other dependents to an annuity so that if you pass away, your loved ones can continue to receive income for a specified period of time.
Another interesting kind of annuity is the split-funded annuity, which is a kind of hybrid between immediate and deferred annuities and offers some of the advantages of both. Depending on your situation, a split-funded annuity may be able to offer the advantage of immediate income while also allowing you the chance to fund the account for larger payments in the future.
Longevity Risk
Every retiree worries about the possibility of passing away before they get to enjoy the fruits of their retirement savings. On the other hand, the prospect of outliving your retirement savings is just as frightening. We refer to this as the longevity risk. There’s no way to predict for certain how long you will live in retirement, but an annuity can reduce some of the fear that you’ll outlive your retirement savings, as annuity payments can be guaranteed for life.
If the owner of an immediate payment annuity lives longer than expected, then the annuitant will have the last laugh, not the insurance company. This is why annuities can be a solid answer to the age-old longevity risk question. On the other hand, annuitants may not be able to leave as large of an inheritance—or any inheritance—to their survivors.
Disadvantages of Annuities in Retirement
Of course, there are several reasons why many investors aren’t typically excited about annuities as retirement vehicles. The following disadvantages of annuities make them unattractive to investors who are confident they’ll be able to achieve a secure retirement without the advantages of an annuity:
Opportunity cost
Illiquidity
High fees
Opportunity Cost
When you have a fixed annuity, your income stream doesn’t change in a bull or bear market. This, of course, can be either an advantage or a disadvantage. When the market performs poorly, annuitants can rest assured they will still have some unchanged retirement income. On the other hand, a fixed annuity payment remains where it is if the market takes off, which may decrease purchasing power for investors who rely too heavily on annuity income.
Furthermore, the returns on variable annuities may be nowhere near the returns you could have earned by investing in the markets yourself. By opting for a retirement product that provides guaranteed income, you restrict yourself from benefiting from the historically appreciating returns on more traditional or alternative investments.
Illiquidity
Like many types of retirement accounts, withdrawing early from annuities often results in a penalty fee. And indeed, some types of annuities can’t be canceled for a refund at all. The niceties depend on the contract you draw up with your insurer, but once you surrender your money to an annuity, you can expect not to touch any of the cash until the accumulation phase is up. In short, annuities are difficult to get out of once you’ve purchased one.
Additionally, annuity payments can’t easily be adjusted up or down once they’ve started. So if you experience an emergency and most of your cash is tied up in an annuity, you don’t have many options to access that cash if you need it. This is why it’s always best for annuity owners to have a substantial emergency fund—or other sources of retirement income—easily available.
High fees
Insurers must reduce the risk they’re taking when they sell you an annuity, which is why annuities typically have high fees. For instance, the “mortality and expense” fee helps them protect themselves from losses associated with clients’ earlier-than-expected deaths.
Additionally, an annuitant may be extra fees when they opt to add customizable riders to their annuity contracts. High fees are one of the reasons why investors have historically been wary of annuities. They are the annuity’s most infamous disadvantage.
How Chicago Trust Administration Services Can Help
Like many investment opportunities, annuities have advantages and disadvantages. The key to deciding whether or not an annuity is right for you is education. You also have to ask yourself what kind of investor you are.
Are you the kind who likes to put your trust in others to manage your money so that you can sit back, enjoy reliable income, and not worry too much about market volatility? Or are you a hands-on investor who wants more freedom than an annuity affords, who balks at the idea of paying more fees than necessary, and who thrives on flexibility rather than rigidity?
The right answer for you may be very different from the right answer for another investor. If an annuity does not seem like the ideal strategy for you, Chicago Trust Administration Services can help you invest in other alternative assets using a self-directed IRA. To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.