Don't let common myths cloud your judgment about including annuities in your retirement strategy.
Saving for retirement can feel overwhelming. It's challenging to predict how much you'll need, especially with market fluctuations becoming more pronounced as retirement approaches. Diversifying your income sources is essential for a successful retirement. Annuities, offered by insurance companies, can act as a form of personal pension, providing guaranteed monthly income when needed. However, misconceptions abound regarding these financial products. We consulted experts to clarify fact from fiction.
Myth 1: Annuities Always Have High Fees
The truth: While fees exist, they vary based on the coverage you select.
All annuities come with certain fees because they are essentially insurance contracts, according to financial expert Brian Karimzad. For instance, securing lifetime guaranteed income and protecting your principal will incur costs.
However, if market volatility concerns you, an annuity can alleviate those worries, says John Thomas, Chief Investment Officer at Global Wealth Management. “Though fees apply, many find the benefits justify the costs.”
Some variable annuities may have fees as low as 0.50% annually. Fixed annuities typically impose an upfront fee around 2% of your initial investment, explains Karimzad.
Myth 2: Purchasing an Annuity Means You're Trapped
The truth: Most annuities allow for withdrawals during the “surrender period” before converting to an income stream.
Many individuals want to know if they can access their funds should their retirement plans change. During the surrender period, most annuities let you withdraw up to 10% of your account balance or your earnings, whichever is higher, without penalties. However, it’s essential to remember that, similar to 401(k)s and IRAs, annuities are intended for funds that will remain untouched until retirement.
“If market fluctuations trouble you, an annuity can help ease those concerns,” states John Thomas.
When considering an annuity, remember it’s a long-term commitment. “Avoid investing funds you may need soon, like for a house purchase,” Thomas advises. Withdrawals before age 59 and a half could incur a 10% penalty alongside regular income taxes on earnings.
Myth 3: Annuities Don’t Generate Significant Returns
The truth: Modern annuity companies are competitive, and fixed index annuities can provide reasonable returns without risking your principal.
With annuities, “you might not capture all market gains, but you also avoid losses,” Thomas highlights. Calculating your returns, you may find that without the down years, you can achieve satisfactory annual returns without excessive risk. This is especially relevant if you use an annuity for your fixed retirement expenses.
Many investment choices in variable annuities mirror those found in mutual funds, offering similar potential returns, according to Karimzad. “Some funds cater to aggressive investors, while others focus on safer short-term bonds.”
Because annuities guarantee income, they can allow investors to take greater risks with other investments, explains David Littell, co-director of retirement income programs at The American College of Financial Services. “Knowing you have lifelong payments can make you more comfortable taking risks elsewhere in your portfolio,” he notes.
Myth 4: Annuities Are Only for Those Already Retired
The truth: Annuities can be beneficial at any age, including in your 40s and 50s.
If you're uncertain about when to incorporate annuities into your financial plan, consult your tax advisor, suggests Karimzad. “Deferring income through annuities can be advantageous. For instance, compounding bond income without annual tax liabilities can help if you’ve maxed out other tax-advantaged accounts like 401(k)s.”
A longevity annuity, purchased around age 60 but not accessed until your 80s, can be a wise choice as healthcare costs rise and the fear of outliving savings becomes more pressing. Allocating a portion of your nest egg to this type of annuity can help mitigate those concerns.
Myth 5: Annuities Require a Large Initial Investment
The truth: Some annuities can be opened for under $25,000, though smaller accounts may incur maintenance fees.
“It's not advisable to annuitize a large chunk of your portfolio — it should only represent a fraction,” Littell states. You can also use an annuity for specific expenses. For example, if you have long-term care insurance but worry about affording premiums during retirement, an annuity can help cover those costs. Many people opt for smaller annuities to ensure certain bills are managed.
Ultimately, annuities shouldn’t consume your entire financial strategy. “They should be a small component that complements your overall financial landscape,” Thomas concludes.
