Without appropriate guidance, annuities can carry the misconceptions of being expensive and hard to understand. However, like other financial solutions, it’s important to review annuities in the context of your overall financial plan to understand how they can help meet your financial goals. We’ll review some common myths and misconceptions, and how you can assess if annuities may be a fit for your wealth plan.
What is an annuity?
Let’s start with a basic definition: An annuity is a contract between you and an insurance company in which you make a lump-sum payment or a series of payments; in return, you receive regular disbursements beginning either immediately or in the future.
There are many types of annuities, such as fixed, variable, indexed, and immediate. A fixed annuity is very stable and earns guaranteed interest, while a variable annuity has underlying investments known as “sub-accounts” that fluctuate with the market. Generally, a variable annuity can be volatile and have stock market exposure through the investment sub-accounts. A deferred annuity earns interest and can provide for future income while an immediate annuity provides income now. An indexed annuity, also known as a fixed-index annuity, can provide growth and income payments at some point in the future.
Some annuities allow for the protection of principal, while a variable annuity involves market risk and the potential for loss. There are two things all annuities have in common:
- They are tax deferred – meaning you do not pay taxes on the earnings or growth until you start to receive income or take withdrawals from the annuity.
- They provide a guaranteed income stream to the annuitant (the person receiving income from the policy) for life, or other payout options, subject to the financial strength of the insurance company that issued the policy.
Common myths and misconceptions about annuities
So why are annuities often misunderstood? Here are some common myths and misconceptions:
- Annuities may seem complicated. On the surface, this may seem to be the case. There are often sub-accounts or index options to select where your money is allocated inside the annuity. Also, some annuities offer multiple riders (optional add-ons) or benefits, depending on the need you’re solving for. Not all annuities are complicated. For example, with a fixed annuity, you earn guaranteed interest and can convert it into an income stream at some point in the future.
- Annuities may seem expensive. The cost of some annuities can be high, especially if you add riders to the policy. Some are less expensive than others or come with specific features and options that you may want. Annuities have early withdrawal penalties, called surrender charges, that typically reduce over time. It’s important to note that annuities are not the only asset that could penalize you for early withdrawals – you also could incur tax penalties for taking out money from your 401(k) or other retirement accounts prematurely. There are tax implications to consider when taking money out of an annuity and deciding whether you use after-tax money or qualified money when funding the annuity.
- If I have other retirement accounts, I may not need an annuity. While the goal is to have enough money in your retirement, besides Social Security and pensions, an annuity is the only financial instrument that can provide a guaranteed income stream for as long as you’re alive. According to Vanguard’s “How America Saves 2024” report, the average retirement account balance for someone age 65 and up is $272,588.1 While saving for retirement is an essential financial goal for most people, some people may, unfortunately, fall short of reaching economic freedom. Annuities can help provide income protection and a cushion against market volatility and longevity risk.
- If I die early, all the money in the annuity is lost. Similar to life insurance or an IRA, you name beneficiaries to your annuity policy. Depending on the type of annuity, your beneficiaries may inherit some or all of the value of your annuity, less any withdrawals, at death. Many annuities also offer joint income options that provide the surviving spouse with lifetime income. With an immediate annuity, you may select from various payout options depending on your unique income needs.
Should I consider annuities?
Let’s consider some positives and benefits annuities may provide. The characteristics that may seem complex help make annuities an attractive and viable option to consider. For example, you can achieve diversification by properly allocating to multiple sub-accounts or index allocations in a variable or indexed annuity. There are also riders you can add to the annuity contract that can provide significant benefits to you as the owner and annuitant of a policy.
Are you looking for a lifetime income stream? A tax-deferred growth vehicle that could provide income in the future? A stable, competitive rate of return over a shorter time? Annuities may help you save and defer taxes if you’ve already maxed out other retirement accounts. If you want to generate income now, a fixed and/or immediate annuity might be the solution and a safe alternative to bank CDs and bonds. Annuities can help to protect your legacy and what you want to leave for your beneficiaries. Since an annuity is designed to provide a stable income stream, you could withdraw less money from your portfolio allowing your investments more time for growth potential.
An annuity, like any other financial asset, has its place and could serve as a solution in your overall financial plan. Ultimately, your financial objectives and goals will help determine whether an annuity is right for you. In the financial planning process, annuities, like stocks, bonds, life insurance, and trusts can play a critical role in securing your economic freedom. We encourage you to speak with your advisor to learn if and how an annuity may fit into your wealth plan. If you’re not a Mercer Advisors client but would like more information, let’s talk.
1 “How America Saves Report 2024,” Vanguard, institutional.vanguard.com.
Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. . All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.
