Advantages of Annuities vs the Disadvantages

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If you are looking for a steady stream of income in retirement, it may be wise to invest in an annuity as a part of your retirement strategy. An annuity is an insurance product that binds a buyer and an insurance company into a contract. In general, the insurance company promises to do something with the buyer’s money like grow it or pay it out over some years. 

This page should serve as a general overview of annuities. After you understand the concept, you can look into the various annuity types.

Annuity Terms to Know

You’ll want to know some key terms when researching which insurance company and annuities are right for you. A few of the important ones are:

Advantages of Annuities

Even though annuity products may come in all shapes and sizes depending on the terms you choose, most work in the following way:

  • You invest in an annuity.
  • The annuity starts making payments to you on a future date or series of dates.
  • A variety of factors, including the length of your payment period determine the size of your income payments.
  • The income you receive from an annuity can be doled out on a monthly, quarterly, annual basis. It can even be doled out in a lump sum payment.
  • Depending on your annuity purchased or preferences, you can opt to receive payments for the rest of your life, or for a set number of years.
  • The amount of income payments you receive depends on if you opted for a fixed or variable annuity. This means whether it was a guaranteed payout or a payout stream determined by the performance of your annuity's underlying investments.

Annuities can be helpful in some situations. In general, some of the advantages and benefits include:

  • Tax-deferred growth and compounding within the annuity contract. Which means you only get taxed on the interest you earn once you start receiving payments, not while it's building up.
  • Guaranteed rates of return on your dollars
  • Guaranteed lifetime payments if you annuitize (in some cases you don’t even have to annuitize to receive this benefit)
  • Other features that may be important to you. These are various bells and whistles that do very specific things, ask your annuitant about these options before signing on any dotted lines.

Note that the guarantees are only as strong as the insurance company that issued the annuity. In other words, if the insurance company fails, the promise is no good. You should mitigate this risk by using only the strongest insurance companies out there.

Disadvantages of Annuities

When it comes to deciding whether the disadvantages of annuities offset the advantages listed above, it's important to note the following:

  • You have to pay for the guarantees somehow. If you don’t need them, don’t pay for them.
  • Some contracts have surrender periods that can tie up your money longer than you want.
  • IRS rules restrict how you take money out of an annuity. Distributions may be taxable and/or penalized.
  • Annuities can sometimes be overused in banks.

With the above points in mind, you can decide how an annuity would impact your finances. They’re right for some people and wrong for others.