Link to the Show / Show NotesFor retirees, the most attractive feature of fixed annuities is the assurance that it'll provide a fixed income for life. But all investments have their good and bad points; and fixed annuities are no different. Let's overview some of their advantages and disadvantages summarized in the table.
Advantages
The three important features of an annuity are tax-deferred accumulation, guarantee of principal, and guaranteed life income. The tax-deferred accumulation – in comparison to a similar taxable investment - allows for greater accumulation since earnings are not taxed away annually.
Annuities have been conservative vehicles for investment. Of course you should always check out the strength of any insurance company you're considering buying from. A good source is to get the Comdex rating of 80 or better from Vital Signs (see a financial professional) or a Weiss rating of B or better.
With the guaranteed life income payout option, you don't have to worry about market downturns that could rob you of income. Also if you can put off your payout until later, you're monthly payout will increase not only from increased earnings but from your reduced life expectancy.
Disadvantages
Because an annuity is a long-term investment with tax-deferred status, the IRS will levy a 10% excise tax penalty on any withdrawal before age 59 ½.
Annuity fees can significantly cut into any withdrawals taken early in the accumulation years. So plan on holding off for 10 years or so to let your earnings offset this effect.
Since your money is placed with an insurance company in an annuity contract, you have little control over the rate of return on your investment. When you buy, find a company that has a history of providing competitive returns If you ask for the interest rate history, you will get it).
Although with a fixed annuity you've eliminated the possibility of market risk on your investment you have created the risk of losing purchasing power. After beginning payments to you you're not able to make any adjustments in case of higher inflation rates. However, if the rate history looked good, the company may be more reactive to raising rates when possible.
Choosing a lifetime income leaves generally leaves no residual investment for your heirs. You can choose options that remedy this, but at the cost of a lower monthly payout.
Fixed Annuities – Pros and Cons
Advantages
· Tax-deferred earnings
· Assurance of lifetime income
· Not subject to market downturns
· Longer deferred gives greater payout per month
Disadvantages
· Early (before 59 1/2) withdrawals are penalized at 10% of withdrawal
· Withdraw too soon after contributing can bring high fees and
· Purchasing power of fixed payout can be degraded by inflation
· Lack of benefits to heirs
Annuities once annuitized cannot be surrendered for value. Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty. Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses.
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