Annuities aren’t all bad. They get a bad reputation because some of them charge high fees and are bad investments, but the idea behind an annuity isn’t bad at all. For many, it’s a way to turn retirement savings into a constant and reliable stream of monthly income similar to a pension, so that you can plan your finances more easily. The big key to watch out for when it comes to annuities are those fees – between the administrative, mortality and expense, and other fees, you could pay through the nose if you’re not careful.
Types of Annuities
There are several types of annuities. Fixed annuities will offer a fixed rate of return and variable annuities will offer a variable rate of return based on the investments in the annuity’s portfolio. Equity-indexed annuities offer a mix of both, you get a minimum fixed rate plus a variable rate based on that stock index (though the rate will be capped at less than the index’s return). In addition to the fixed and variable aspect, there’s a deferred version (and immediate version) of both. Deferred means you’re putting off the earnings until the future, whereas immediate means you’re getting a monthly cash flow today.
In addition to the deferred/immediate aspect and the fixed/variable/indexed aspect, there are add-ons you can get that will cost you even more. It’s like selecting the flavor of your ice cream and then picking the toppings afterwards.
On their own, annuities aren’t bad ideas, it’s only if you get one with big fees. Annuities will always charge an annual management fee, which according to Morningstar will average 2.37%, though you can find low cost alternatives at firms like Vanguard. In addition to annual fees, you may have a surrender fee if you sell your annuity in the first year or two. Finally, there is also a “mortality and expense” fee that pays for the insurance part of your annuity, commissions, administrative expenses, etc. The average M&E charge is 1.15% according to the National Association of Variable Annuities (NAVA).
If you keep an eye out for the fees and understand what you’re buying, annuities aren’t dangerous at all.