Are Annuities a Good or Bad Investment

For any investment, a determination must be made as to its suitability, and ultimately, it potential to meet an individual’s investment objective within the bounds of his or her tolerance for risk. The most fundamental rule of investing is that no one investment is right for everybody, and that it is the financial profile of an individual which determines whether any one investment is suitable or not. Annuities are certainly not for everybody, and if an individual’s needs, priorities, investment objectives or risk tolerance is not carefully considered, they could turn out to be a bad investment. For the right person, annuities can be an extremely good investment.

Good or Bad Depends on the Individual’s Financial Profile

Annuities are designed as a long term investment with special features that can benefit investors who seek tax advantages, preservation of principal, security, predictability and certain guarantees. While some annuities, such as variable annuities, do offer the potential for higher returns, investors who don’t have these objectives or concerns may be better off investing in mutual funds. A breakdown of the key features of annuities is one way to determine if they would be a good or bad investment.

Deferred Taxation of Earnings

The taxation of earnings inside of annuities are treated the same as qualified retirement plans in that they are not taxed currently. They are allowed to accumulate without taxation until the time they are received. While this can be tremendous advantage for people in higher income brackets, it would not benefit people in lower tax brackets. The people in higher tax brackets also have to be willing to wait until after the age of 59 ½ to withdraw their funds in order to avoid a 10% IRS penalty. Annuities can be converted to income (annuitized) at any age which would not trigger the penalty.

Fixed Annuity Rates

The rates on fixed annuities are competitive with any taxable equivalent vehicle. In fact, annuity rates tend to be slightly higher than term deposits such as bank CDs. In many annuity products, the rate is guaranteed for a certain period of time, after which, it is adjusted based on the prevailing rates at the time. So, it is possible that, the new rate will be lower than the initial rate; however, most annuities include a “bail-out” provision which allows investors to transfer their money to another annuity without incurring taxes, fees, or a penalty.
For investors who seek safety and stability for at least a portion of their investment portfolios, annuities are a great investment, and the fact that their rates are competitive means that investors don’t have to sacrifice returns for greater safety. If you believe that interest rates will increase in the future, then fixed annuities can be a good investment. For investors who are more risk oriented or concerned about the possibility that future interest rates could drop substantially, annuities could turn out to be a bad investment.

Annuity Withdrawals

Annuities do provide their investors with some access to their funds. Investors can access their accumulation account to the extent that the annual withdrawal does not exceed 10% of the balance. Should they need to withdraw more than 10% in a year, they will incur a surrender fee which could range from 5% to 12% in the first year. Each year, the surrender fee is reduced by a point, so eventually investors would have complete access to their funds (but could still incur a 10% IRS penalty if younger than 59 ½).
For investors with a long term time horizon and sufficient liquidity among other assets, annuities are good investments over a long period of time. Investors, who haven’t accumulated sufficient liquid savings or alternative assets, may find annuities to be bad investments if they find should find themselves in need of funds in the short term.

Income Guarantee

While annuities are popular accumulation vehicles, their original purpose was to secure a person’s future income so that it could not be outlived. Today, annuities still provide the best solution for people whose primary concern is capital preservation and a secure lifetime income. For investors who lie awake at night wondering if their income sources will last their lifetime, fixed annuities may be the best solution. They must be secure in the knowledge that the capital they apply to the annuity is inaccessible as it must be committed to the life insurer so that it can guarantee the lifetime payments.
For investors who are concerned with giving up complete control of their asset to a life insurer, annuities would not be a good investment. If, however, they controlled other assets that were also producing income, and were available in case of an emergency or short term need, then an income annuity could provide the income safety net which would make them feel much more secure.


As with any investment, annuities must be considered in the context of a person’s own financial objectives, preferences, priorities and risk tolerance. When a person’s financial profile is a match for the features and benefits of annuities, it can be a great investment choice, especially when it is a part of an overall investment strategy consisting of a diversified and balanced portfolio.

Why Invest in Annuities

When considering any investment, a number of questions should first be posed that address all of the core issues surrounding your individual financial situation, concerns, priorities and your tolerance for risk. Only then can you conduct an honest assessment of an investment in terms of its suitability and its ability to meet your specific needs.

Annuities present investors with a great number of potential benefits, but they are not suited for everyone. Understanding how annuities work is important, but of greater importance is to know how they work in the context of your own situation. Knowing your specific concerns, priorities and purposes is the best way to know why you should invest in annuities.

You Should Invest in Annuities if….

You want to avoid taxes

One of the primary reasons why investors choose annuities is that the tax treatment of earnings is similar to that of qualified retirement plans. There are no taxes due as long as the earnings are left to accumulate inside the annuity. Only after they are withdrawn are they taxed as ordinary income. Investors in the top federal and state tax brackets benefit from the tax savings that mount over a long period of time. The taxes on earnings can be deferred even further if the annuity is converted to income because the earnings will be spread out over the income period and taxed only as they are received. Additionally, because each income payment consists of both principal and earnings, only a portion of the income payment is taxable.

You prefer stability and predictability

Some investors are completely risk adverse and prefer investments with predictable outcomes, even if it means accepting a lower return. Fixed annuities provide competitive rates of return based on fixed yields. Indexed annuities offer the opportunity to achieve returns that are better than fixed yields with no downside risk. Even variable annuities with their separate investment accounts and potential for higher returns can provide some predictability if they offer a minimum rate guarantee option.

With the minimum rate guarantees, annuities can be an effective way to provide more stability to the portfolios of more risk oriented investors. By adding annuities as a safety net to a diversified portfolio of investments, investors will feel more comfortable with some of the risks they assume on other investments.

You can’t sleep at night

The biggest fear confronting pre-retirees today is the possibility of outliving their income. Most Baby Boomers report that their savings are inadequate for generating enough income to maintain a comfortable retirement for their ever expanding life expectancies. As their retirement time horizon shortens their anxiety increases. Fixed annuities are the only investment vehicle that can ensure that your income will last as long as you do. If you want at least a portion of your income guaranteed for life, an annuity can create a foundation of income upon which other sources can be added.

You can’t tolerate any more losses

Most investors who experienced the tumultuous financial markets of the previous decade probably feel the same anxiety over the diminished value of their 401k plans. Many will reach their retirement date with much less than they had anticipated. Worse, some may die prematurely leaving their family with less than they were hoping for to provide them with financial security. During that same time, annuity investors were comforted with the knowledge that their annuities protected their principal with a guaranteed death benefit.

Indexed annuities offer the opportunity to participate in the returns of the stock market without any downside risk. Although the upside returns are capped, generally at rates that greatly exceed the returns of fixed yield investments, indexed annuities will credit a minimum rate if the market’s decline. Even variable annuities provide downside protection if a minimum rate guarantee option is purchased with the contract.

You understand that increased security and predictability comes at a cost

Annuities offer a tremendous amount of financial security and predictability for shell-shocked investors who have endured wide swings in their portfolio values, and now must content with the uncertainty of their income sources. The question usually comes down to how much is that security and peace-of-mind worth and would you be willing to give up some return or pay a little more to get it?

Many people could not tolerate a repeat of the last decade, and fewer people could afford it. Annuities do come with certain costs not found in other investments. There are expenses that cover insurance and administrative costs. With variable annuities, investment management fees, similar to those charged by mutual funds, can increase the cost. Withdrawals from annuities made early on in the contract can result in surrender fees. In addition, the withdrawals could be subject to IRS penalties if they are made prior to age 59 ½.

So, the questions always go back to what is the best investment choice for your particular financial situation and investment temperament. If your temperament has been shaped by some of the conditions listed above, an investment in an annuity may be the right choice for you.

How to Allocate Funds Inside A Variable Annuity

Annuities are contracts between an investor and an insurance company that allows the purchaser to accumulate funds without getting taxed on the income until the first withdrawal is initiated. There are several of different types of annuity products that exist and are offered, each with their own particular benefit and features that may appeal to the investor. For the savvy and novice investor alike, various levels of risk and investment controls can also be appropriated with annuities.

A variable annuity is a tax-deferred annuity and is one that allows its purchaser the freedom to choose among various types of mutual funds and to allocate a particular percentage to each fund with varying amounts of risk. Each variable annuity issuer may provide a number of diverse mutual funds to choose from, including a standard fixed annuity fund option that could complete a portfolio. Ultimately, before electing a variable annuity, the investor is should determine the amount of risk he or she is willing to stomach and then research all available options provided. Some insurance funds, for example, provide higher risk international mutual funds; others provide “socially responsible” funds which meet a particular criteria for companies those funds invest in.

A variable annuity is broken down into two general phases: the accumulation phase and the distribution phase. During the accumulation phase the investor has the ability to allocate his or her investment payments in a number of different mutual funds and with particular percentages for each. The investor usually invests in annuities with either “after tax” or “pretax” funds, which need to be considered when the tax burden is imposed during the distribution or withdraw phase. The distribution phase can be set up according to the investors needs after a certain period of time. For example, the investor may elect to withdraw the funds in one lump sum or take out a percentage per year.

The uniqueness of the variable annuity is that it allows the investor to choose the weight of investment in each fund he chooses. So for example, an investor may elect to allocate 25% of his funds into an international higher risk mutual fund, 40% into a fixed rate fund, and the 35% into a stock fund. Now the overall performance of that variable annuity will be determined by the performance of each of the allocations over a period of time. Each insurance company issuing the annuity may vary on their options, so you should thoroughly research the available funds and their market performance. During the accumulation phase, you may be able to transfer or change mutual fund allocations and their percentages without paying any taxes, but you may incur a fee by the insurance company for the change.

The ultimate factors that may determine your allocation comes down to your savings goals, your comfort level with the risks involved, and your age. For example if you are in your early 30s than you may elect to have some of the mutual funds allocated to a higher risk and potentially higher risk international stock fund. If you are in your late 60s, you may elect to have you larger portion of your fund to be allocated to a fixed fund. If you have a several annuities and other savings vehicles you may consider a balanced approach of allocating a percentage of the funds based on your level of need for the long term.

The most important thing you can do is stay engaged with your variable annuity account. Some insurance providers may offer different mutual funds that may interest you as time passes and that can deliver the return on investment with the level of security you are interested in.


Pros and Cons of Variable Annuities

There are several important key elements with variable annuities hat may appeal to investors. Variable annuities as investment vehicles, deliver periodic payments for a predetermined amount of time, such as 20 to 30 years, or the rest of your life. This special characteristic of this type of investment removes the possibility that you may outlive your assets and allows for predictable streams of income throughout a specified period of time.

Another important feature is that variable annuities allow you to predetermine a beneficiary in case you happen to die prior to the company delivering payment on the purchases you have already made. This is particular important for investors who contribute funds and would like to protect and re-designate those funds to a spouse of child in case of their death.

Annuities are contracts purchased for promises of payment in the future and are usually backed by insurance companies. Variable annuities are unique among the other types of annuities because they give the investor a tremendous amount of freedom to invest in several types of “subgroups” based on his or her level of comfort. Usually these subgroups come in the form of stocks, fixed money market vehicles, or bond funds.

Another positive benefit is that the accumulation that occurs is tax-deferred. This means you do not pay any taxes on the income gained throughout the year or throughout the entire accumulation phase of the annuity. For example if you made 10% each year for the last 15 years, you would haven’t have to pay a dime of taxes based on those earnings until you started withdrawing on your funds at some point in the future. This provides the ability for you to grow your income and “defer” your taxes to a later date, when at that time, you may be in a different tax bracket altogether.

With variable annuities you are able to choose the funds you want based on the risk you want to take. So for example, if you are a younger investor and would be interested in generating more funds through a higher yielding and higher risk account, you may choose a particular fund that met those expectations or particular criteria. Another feature that is important for many investors is that if you need to change from one variable annuity to another, you can change accounts without incurring any taxes on that money – although the insurance company may charge you a transfer fee.

There are a few cons to the variable annuity which, in general, may exist for all annuities. Variable annuities are not backed by the FDIC and thereby assume a greater possibility of financial loss if the company issuing the promise of repayment becomes insolvent. Nevertheless, there many states do offer a certain degree of investor protection, which may at as a quasi FDIC. Further, a clear precedent has been established historically, that in case an insurance company goes under, another insurance company or group of companies will step in to buy up the contracts from the insolvent company, albeit for lesser amount of the original payment.

Still, variable annuities remain an attractive and safe option for investors for the long haul providing a level of freedom and flexibility that adheres to the needs and goals of each investor. As with any investment, risk management should include a full assessment of the prospectus and soundness of the issuing company.


Understanding Variable Annuities

Variable annuities are contracts that exist to between the issuer, usually an insurance company, and the investor. After its purchase, the annuity makes periodic payments to the investor which can range from an immediate payout or future payments starting on a specified date and lasting for a specified time. Generally, a variable annuity offers a range of investments opportunities that begins when purchasing it in either a lump-sum or pay-as-you-go method. The money invested is then taken by the annuity provider and placed in various mutual funds and/or several equity stocks at the investor’s discretion.

As the investor is able dictate the percentage and type of investment, the ultimate value of the variable annuity depends on several factors; including the amount of the original investment and how the actual annuity performs with each of these “subaccounts” that were elected by the investor – such as bonds, mutual funds, and other equities. For example, it is common to have a particular percentage of your annuity funds to be invested in higher or lower risk mutual funds and perform differently. That percentage increase and decrease will ultimately affect the overall performance of the annuity. The election of each fund, its risk, and its overall weight lies on the discretion of the investor giving enormous freedom in the market place.

One of the essential benefits that come with variable annuities is that they allow you to have a guaranteed “death benefit.” For example, if you were to die before any payments were made to you, you are able to designate a beneficiary who would receive those payments in lieu of you. The amount received by your beneficiary would be, at minimum, the investment payments you have already purchased.

As a tax-deferred vehicle, variable annuities allow you to accumulate assets and pay no taxes on the gains of the investments until you actually make a withdrawal on your account. Another feature that may offer flexibility to the investor is that the variable annuity allows you to transfer money from one account to another, without being taxed or penalized. In fact, only at the time the money actually withdrawn is when the investor must pay an income tax at their standard rate. If you take payments before your retirement or before you turn 59.5 years of age, you will have to pay a penalty fee as you do with other similar annuities, which is usually 10% of the value of the withdraw.

The structure of the variable annuity essentially comes in two different parts: the “accumulation” phase, or the period that the investor makes payments for a designated set of destinations. Variable annuities can, at the same time, provide the opportunity to choose a safer fixed-rate of return, very much like a typical “fixed” annuity. This provides the investor greater flexibility, diversity, and stability that they might be searching for in a balanced portfolio.

During the payout period you can also choose to have your investments plus earnings given to you in one “lump sum” or you may choose to receive payment installments over a specific period of time, such as 20 years. Investors can also elect to be paid out in a manner that is indicative of the market performance of the annuity. Depending on how the investor paid for those investments (either through after tax or pre-tax dollars) will affect his tax obligation when he makes his withdrawals. Nevertheless, the ability to defer taxes on earnings, invest in a number of mutual funds according to the investors aversion to risk, makes this investment a particular favorite.