Are All Annuities Bad?

It is nearly impossible to make a broad generalization pertaining to a specific investment and think that it will apply to all individuals. Whether that applies to the world of investment or any industry, that is the reality, and downside, of any generalization.

That is why the generalization that annuities are bad for consumers is not true across the board, as there are always outliers or situations that prove the contrary.

Not all annuities are “bad,” but there are many aspects of annuities that are less than favorable to investors and the future of their wealth. Here are four downsides to annuities

1. High fees

This generalization may prove to be true in every case, and it’s pretty simple. If you lower your cost, you will get a better deal, and your investment performance will improve.

So how can one determine if the fees are high? Often, investors will compare annuity costs to those of a mutual fund. However, the comparison is not equal. An annuity could provide benefits that a mutual fund does not. Therefore, it’s best to compare your annuity to a similar annuity plan with similar benefits. If the annuity you compared yours too has significantly lower rates, well then you know your fees are too high.

2. Purchasing products you don’t need

Don’t we all dream of reaching that place of financial independence where we can purchase anything we want, “guilt-free?” Annuity extras, on the other hand, are often add-ons that can only contribute to the complexity of annuities. These optional add-ons come in the form of death benefits, extra income benefits, lifetime income, and more. If these are important to you, then they aren’t necessarily a bad thing, but if income isn’t a concern, and you have an income rider that’s costing you 1% each year, then that’s a bad situation. Therefore, be sure only to add rider benefits that specifically address your needs to increase income and lower costs.

3. Not understanding your annuity

A word to the wise is to avoid anything that you don’t understand or can’t explain.

One of the most common problems, when consumers purchase an annuity, is that they don’t fully understand how they operate. While you don’t need to reach expert status, you should be able to recite and explain the basics to another person. Investors also typically don’t understand how they can grow and how the benefits work. Especially seen in indexed annuities, if you own an annuity of this type, you should understand how growth can be limited by a participation rate or index cap. Lastly, investors often fail to understand that early withdrawals could cause a surrender charge penalty of up to 10%. If you’re unfamiliar with the terms of your annuity contract, you could find yourself in a bad place.

4. Being misled

Since annuities are insurance products sold by insurance agents, not all annuities are held to a fiduciary standard. For some agents, their only goal is to sell as much product as possible to receive the maximum commissions. Often, widespread annuity advertisements, such as television shows or radio commercials, won’t share all of the important details about an annuity contract. Many purchasers of annuities don’t fully understand the terms of their condition, which only leads to disappointment down the line. For example, some indexed annuity advertisements include a promise that you can “participate in the gains of the S&P 500 with zero downside risk.” In most cases, this is true, and growth options can often include an index option linked to the performance of the S&P 500 or a similar index. What they don’t mention, however, is that gains have participation rates and cap limitations and that by participating, you’ll have to surrender full liquidity for 6-10 years. It goes without saying that an advisor making these misleading claims is a bad sign.

Bottom Line
This does not mean that all annuities are wrong. However, they do come with a tradeoff. If you find an annuity contract with terms that suit your needs, you fully understand the limitations, and the costs are low, annuities can be an excellent financial tool. If it sounds too good to be true, it is, and you should explore your retirement income options elsewhere.