“When people are reaching retirement age, they have more retirement wealth than at any time in the rest of their life,” William Gale, a senior fellow in economic studies at the Brookings Institution, said at an April 18 forum in Washington, D.C., on the youngest boomers’ retirement prospects. “It’s probably not the optimal time for them to think about outliving those resources.”
If you decide to cancel or take money out of an annuity before it matures (typically a period of six to eight years), you could face steep fees. Surrender changes can be as high as 7 percent of the total value of your annuity, according to Annuity.org. If you are under age 59½, you may owe the IRS a 10 percent penalty as well.
What to consider: Annuity contracts should lay out the terms and fees associated with the “surrender period.” The penalty typically declines year by year and goes away once the annuity matures.
Some contracts grant emergency withdrawals without surrender charges in certain situations, such as a nursing home admission or terminal illness, but these “crisis waivers” often come with their own fees. Weigh the various costs and consider how comfortable you are limiting liquidity in your later years.
The problem: You might not live long
A basic life annuity generally offers the largest monthly payments, and they last as long as you do. That’s a pretty good deal if you live for 20-plus years in retirement, which is not unusual — you’ll probably get considerably more money back than you put in. But if you die within a few years, you’ll have only received a fraction of your investment.
What to consider: Many annuities do offer a death benefit, which allows you to add a beneficiary, typically a spouse or child, who will inherit all or part of your monthly payments when you pass away.
“A huge majority of annuities that are sold for income purposes have some sort of feature for a beneficiary,” Look says. “So that concern is relatively easily to overcome.”
The caveat is that opting for a death benefit usually means smaller payments than if you choose a plan that’s contingent only on your own lifespan.
The problem: Limited growth
Annuities are designed to offer a predictable income stream when you retire. But the returns you’ll receive may pale in comparison to what you’d get if you invested the money in the stock market instead.
What to consider: When weighing an annuity, think about your risk tolerance. Different annuities offer different opportunities to grow your assets, and different levels of risk.
For example, fixed annuities offer a predictable rate of return, while fixed index annuities offer the possibility of more growth by tying returns to the performance of a market index, such as the S&P 500. But returns on a fixed index annuity are often capped and may end up being lower than the actual gains in the market index it tracks.
“They are a hybrid product, but they are not going to outpace major stock markets,” Look says. Some fixed index annuities offer higher “teaser rates” in the early years of the contract that decline over time. These annuities are “very, very complex,” he warns.
“The important thing for investors to focus on, in consultation with their financial professional, is whether the protected accumulation, lifetime income and other features available through annuities make sense relative to costs and opportunities for each individual financial plan,” Buckingham says. “There really is no one-size-fits-all solution.”
Nicole Ridgway is a business and personal finance journalist based in Brooklyn, New York. She has worked as an editor and reporter at CNN Business, AOL, SmartMoney.com and Forbes.
