Are Annuities Right for You? Here’s How to Decide

Consider Arthur, a small business owner who recently sold his company and wanted a safe place for part of his nest egg. He was comfortable with the idea of a long-term investment and also wanted access to his money if he needed it.

An agent pitched him a deferred annuity, promising a guaranteed interest rate much better than a bank CD. The agent talked about its safety and the guaranteed lifetime income. Impressed, Arthur signed a contract, unaware of the fine print.

A year later, Arthur’s son called in a panic. The roof on his family’s home had caved in, and they needed a substantial amount of money for emergency repairs. Arthur immediately thought of the money he had in the annuity. When he called the insurance company, he was told he would face a 10% surrender charge if he withdrew the money.

He was shocked. As it turned out, the agent had mentioned the surrender period, but had glossed over its severe financial penalty, leaving Arthur in a financial bind.

This is a classic example of a mismatch between the investor and the product. Arthur was the type of person who needed liquidity and access to his money. The annuity was the wrong tool for his financial goal.

Arthur’s experience shows why it’s critical to ask: who should buy an annuity, and when does it make sense to avoid one?

Let’s start on the upside. Annuities offer an additional income stream to help fund your golden years and reduce the risk of running out of retirement savings. It’s the only type of investment that offers guaranteed lifetime income. Risk-averse or inexperienced investors may also find annuities appealing due to their principal protection features. Insurers that sell them virtually never go out of business. Bottom line, annuities make sense for lots of people.

Let’s move on to the next points. Folks should be very fussy about the annuities they buy – helped by reading some good annuity articles. And some seniors should know not to buy an annuity at all. Here are the key pointers:

When annuities should be side-stepped

+ Have enough income for retirement.  An annuity may be unnecessary if you’ve saved enough for retirement and Social Security benefits will fill any income gaps.  In this case, you might be better off, for example, using the money in long-term insurance 

+ When liquidity is needed. Annuities are long-term, illiquid investments. If you anticipate needing access to your money for short-term goals, unexpected emergencies, or other expenses, an annuity is a poor choice. These contracts can have long surrender periods up to 12 years.  If violated, surrender fees can be steep, as Arthur learned.

+ A short life expectancy. The primary benefit of a lifetime annuity is the promise of income for as long as you live. If you are in poor health or have a shortened life expectancy, you may not live long enough for the total annuity payouts to exceed your initial investment. In such cases, other savings vehicles or life insurance are usually more suitable. 

+ High-interest debt. Financial advisors generally recommend that you first pay off high-interest debt, such as credit card balances or personal loans, before making a long-term, non-liquid investment like an annuity. The returns from an annuity are unlikely to outpace the interest you are paying on your debt.

+ Non-maxed retirement accounts. For most people, it’s financially more advantageous to first contribute the maximum amount to tax-advantaged retirement accounts, such as a 401(k) or IRA. These often provide tax benefits, lower fees, and more investment flexibility than annuities.

+ When people are young.  Most annuities are best suited for individuals closer to retirement age. Younger investors typically have a longer time horizon and can afford to take on more risk for potentially higher returns through diversified investments such as stocks and index funds. In addition, some annuities are probably insufficient for a younger person’s long-term growth needs.

Be Fussy about the annuity/annuities you buy

+ Ask good questions before buying. Clear answers to key questions are paramount. What type of annuity do you want? How long are surrender fees? How long is the contract term? Are annuity renewal rates likely to be relatively competitive? And, too, pay attention to what your broker says. If he or she seems too pushy or too reliant on jargon, move on to somebody else.

+ Strenuously avoid choosing the wrong annuity.  Choosing the wrong annuity can result in high fees and poor returns. Get a good feel for different types of annuities and be absolutely sure the annuity you purchase is definitely what you want. Different types of annuities seek different goals.

+ Don’t invest solely in annuities. Because annuities have illiquid surrender charges, you should never invest more than 35 to 40% of your financial assets in them.  You don’t want a big problem if life takes an unexpected twist. And when you are ready to buy a select annuity, try to make sure it has an insurance rating of at least an A- or A. 

Again, as noted, annuities make sense for many retirees and pre-retirees. It’s no coincidence that annuity sales in America have set records three years in a row. But be thoughtful about your pending purchase and make a point of learning about the ins and outs of annuities. This way, they know whether they are truly attractive – and whether in fact annuities are right for you.