Annuities in Financial Planning | Evaluating Their Merits and Drawbacks
In the realm of personal finance, individuals have a range of tools to secure their financial future. Annuities, which are essentially contracts with insurance companies, are one tool gaining momentum in today's interest rate environment. However, it's crucial to assess their advantages and disadvantages thoughtfully. In this article, we'll explore the pros and cons of annuities to help you make informed decisions about their role in your financial strategy.
The Pros of Annuities
Income Stream: An income or immediate annuity is a contract between the buyer and insurance company to provide a regular income over a stated period. The payment could be guaranteed for a set period such as ten years, or for the remainder of your life. Some buyers find comfort in the guarantee of lifetime income. Whether you choose fixed annuities with unchanging payments or variable annuities linked to market performance, this stability can provide peace of mind.
Tax Advantages: Annuities offer tax-deferred growth, meaning you won't be taxed on earnings until you start receiving payments. This tax benefit can enhance the growth of your savings over time.
Death Benefit: In the event of your passing before receiving all payments, annuities often include a death benefit that passes on to your beneficiaries.
Asset Protection: Annuities can offer protection against creditors in certain cases, making them a valuable tool for safeguarding your assets in a well-defined estate plan. You’ll want to work with someone versed in your state laws regarding asset protection before implementing an annuity strategy.
The Cons of Annuities
Lack of Liquidity: Annuities often come with surrender charges and penalties if you need to access your funds before a specified period. This lack of liquidity can limit your financial flexibility and adversely affect portfolio decisions. Remember an annuity is a contract, you are obliged to follow the stipulations, no matter the cost.
Fees and Expenses: Annuities may have high fees, including management fees, administrative costs, and surrender charges. It's essential to understand these fees upfront. Many advisors who sell these products will claim their commission comes from the insurance company. The commissions tend to be lucrative for those who specialize in annuities. As an informed consumer, you know the company passes that cost to you in one form or another.
Complexity: The various annuity types and features can be complex and challenging to comprehend fully. It is often said that annuities are sold, not bought. Meaning simply, one rarely seeks out this type of contract, rather they are sold by trained sales professionals. When approached with an annuity opportunity, it is best to ask yourself if you are crafting a financial plan or buying a product.
Inflation Risk: Fixed annuities may not adjust for inflation, potentially reducing your purchasing power over time. Your own circumstances are likely to change during the contract period, and most annuities leave you little flexibility to adjust.
Market Risk (Variable Annuities): While variable annuities offer investment options, they also expose you to market risk. Knowing what you own inside these contracts can be difficult, and the options are rarely favorable for the end investor. If you are comfortable with investment risk, there is no need to combine it with other characteristics. A good financial plan will account for the funds you need to keep safe, and the funds you are able to invest.
Deciding whether to incorporate annuities into your financial plan is a significant decision that depends on your specific financial goals and circumstances. Annuities can be a valuable tool for ensuring a stable income stream, especially in retirement, but they come with trade-offs. Carefully consider the pros and cons, evaluate your liquidity needs, and be mindful of the associated costs and complexities.
When contemplating annuities, seek advice from a financial advisor who can provide personalized guidance based on your unique financial situation. Remember that a well-rounded financial plan often includes a mix of different assets and strategies, in rare cases, annuities could serve as a piece of the puzzle to help you achieve your long-term financial goals.
About the Author
CFP®, MSAPMChief Investment Officer