Annuities have a bad reputation.
They can be seen as expensive and difficult to understand. But it is important to not jump to any conclusions. Similar to other financial tools, it is best to ask “what role can annuities play in my overall finances?” rather than to avoid them owing to myths or misconceptions.
If you would like more information about annuities, we would welcome the opportunity to help you gain a more in-depth understanding of how they work and explain the different types. We can also provide you with examples of how annuities have been used in real-life situations as part of an overall financial strategy.
To help you get started, here is a high-level overview of some key items to understand.
What is an Annuity
An annuity is a financial contract that creates an agreement between you and the issuing party, which is usually an insurance company. You agree to give the company a sum of money, either in installments or as a lump sum; in exchange, the company agrees to make regular payments back to you over a period of time.¹
Keep in mind that any guarantees with the annuity contract depend on the issuing company’s claims paying ability.
Pros & Cons
Benefits
Provide a source of funds: With an annuity, you can transfer the risk of living a long life—and needing money for decades in retirement—to an insurance company. An annuity can be structured to provide you with another stream of income to help manage your monthly expenses in retirement.²
No contribution limits: Unlike other retirement plans, annuities have no contribution limits. So if the annuity strategy you are considering requires a large investment, you may not have to be concerned with contribution limits.
Tax-deferred growth: Like other retirement plans, an annuities contract is tax deferred, meaning you do not have to begin paying taxes until you start receiving annuity payments.³
Limitations
Cost structure: Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, and mortality and expense fees; they can also have charges for optional benefits.
Access to funds: Most annuities have surrender fees that are usually the highest if you take out the money in the initial years of the annuity contract. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies).
Final Thoughts
If you think an annuity could play a role in your overall financial strategy, please reach out so we can hear about your ideas. We may have a flowchart or an illustration that may help you better visualize how the various types of annuities work.
1. FINRA.org, 2023
2. Annuity.org, 2023
*This article is for information purposes only and is not intended as a substitute for real-life advice,
so make sure to let your tax professional know when you intend to begin drawing income from an
annuity.
