Find out from Money Girl what an annuity is, and the pros and cons of using one for retirement income.
3 Cons of Using a Fixed Annuity for Retirement Income
While there are pros to just about every financial product, there are also cons. So always weigh the advantages against the disadvantages before you make a financial commitment.
Con #1: Loss of Liquidity
After you purchase an annuity or make contributions, your money is locked in for a certain period of time. If you take the money out, it’s typically subject to a surrender charge that could be 8% or more of your account value after one year. The charge generally decreases each year until it gets to zero. However, some products allow for a certain amount of penalty-free withdrawals.
Once you annuitize the account, or start receiving income, you give up access to your account in exchange for the cash flow.
Con #2: Early Withdrawal Penalties
Since annuities are designed for retirement, the IRS typically charges a 10% penalty if you withdraw gains from the account before reaching age 59½. Plus, you also have to pay ordinary income tax on those earnings. However, as I previously mentioned, you’re never taxed on withdrawals of your principal because they are paid into the account on an after-tax basis.
So, just like with an IRA or 401(k), you should never put money into an annuity that you might need to spend before reaching the official retirement age of 59½.
Con #3: No Growth Feature
Fixed annuities offer no or little potential growth when compared to other options for your money, such as investing in stocks or mutual funds. However, a smart way to get the opportunity for growth while protecting your principal from market volatility is with a fixed indexed annuity, or FIA. It gives you guaranteed income based on the performance of an index, such as the S&P 500, that’s used as a benchmark.
But with a fixed indexed annuity, you’re not directly invested in the index or market. So you balance risk and reward by earning more when the market is up, but are guaranteed to never lose value when the market is down. That safety gives you peace of mind that your money is safe from fluctuations in the market, which can make all the difference during retirement.
Visit the Indexed Annuity Leadership Council website at indexedannuityinsights.org to learn more about annuities. They have some great interactactive tools, calculators, and videos to help you build a retirement nest egg.
Do Your Homework Before Buying an Annuity
Remember that the purpose of an annuity is to transfer the risk of running out of principal or income in retirement to an insurance company. Annuities come with terrific benefits that you won’t find in any other financial product—but they also have drawbacks. The pros and cons that I’ve covered are not a complete list.
So, do your homework and make sure you understand all the features of an annuity, and how it can help you solve your financial needs in retirement, before jumping in.
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