Are Annuities a Good Investment?

Buy annuities for their guarantees, not necessarily as an investment

A silver piggy bank with a stopwatch attached.
Annuities, in some situations, are good investments, however, the biggest reason to buy them is for the insurance feature.. Dimitri Otis / Digital Vision / Getty Images

Are annuities a good investment? It’s an interesting question, because, honestly, there are many types of annuities that are not investments at all.

You can buy annuities for safety, for long-term growth and protection of your money, or for income. For example, a fixed annuity might make an attractive alternative to a CD, a variable annuity might be bought for long-term tax-deferred growth and, and if it has an income ride it may offer protection of your money should the market go down, and an immediate annuity is bought for current income purposes.

The only real way to determine if an annuity is a good investment for you is to have a plan. Your plan should dictate what your investment goals are and show you how to make choices that help you accomplish those goals.

When an Annuity is a Good Investment

I would not classify all annuities as investments. First and foremost an annuity is an insurance product, which means you buy it to reduce risk. Some annuities, like variable annuities, have a selection of stock and bond portfolios available as investment choices inside the insurance contract; other annuities are truly insurance with no investment component at all.

Considering this there is one thing an annuity does really well, which is to provide a hedge against longevity risk (the risk of living far longer than you thought you would), and if you are buying it for that reason, an annuity can be a good investment.

An annuity might be the perfect investment choice for you if you have carefully walked through all the questions in Should You Buy an Annuity and determined that the answer is yes.

If you understand all the fees and restrictions and after considering all of this the annuity accomplishes your goals then it may be appropriate for you. You should understand how the annuity income is taxed, when income can start, what investment options are available, and how the annuity compliments other investments you have.

When an Annuity is Not a Good Investment

When someone is trying to sell you an annuity without looking at your entire financial picture I would be cautious. Many people selling annuities mean well, but they may not have a thorough understanding of the products they are selling, they often do not have a good grasp on the tax implications, and if they haven't done any planning for you they can't see how that product is going to fit into your retirement picture.

In particular, I have heard sales people say “what do the fees matter if it does what you want?” I disagree with this. High fees lower your return. In Variable Annuity Compared to Index Funds I provide a specific example of how high fees in some annuity products can affect you.

Don’t buy an annuity unless you have crafted a plan and understand how the annuity fits in. Annuities are not going away, so there should be no pressure or sense of urgency to buy until you’ve done your homework. Some sales representatives will tell you that an annuity product is only going to be available for a short period of time.

This is often true, as insurance companies will discontinue products from time to time, but not to worry, a similar product with similar features will likely soon pop up in place of the old one.

All Annuities Are Not Alike

In All About Annuities I describe the different types of annuities and the pros and cons of each. Once you understand the different categories of annuities you’ll know what questions to ask about the particular annuity you might be considering.

Compare broker-sold annuities to no load annuities before you buy. Broker-sold annuities are sold by someone who carries an insurance license and possible a securities license too. You buy no load annuities direct, and they have lower fees, but you must do your own homework and research; that is the trade-off for paying lower fees. Some fee-only financial advisors will also help you select an appropriate no load annuity if it fits in with your plan.

Do your homework and read up on alternatives to annuities before making a final decision. You’ll also want to feel comfortable asking about annuity fees. Any reputable advisor or company should explain all costs to you before you buy. If someone is not willing to take time to explain the fees in their product or explain to you how they are compensated from the sale of that product then don’t buy from them.

Bottom line: An annuity can be a good investment if it is part of a well-structured retirement income plan and you understand what it does for you and why you are buying it.

Continue Reading...