Five Drawbacks of Buying a Life Insurance Annuity

Before the recent recession, life insurance annuities had a bad reputation and seemed out of favor of many financial planners and professionals on Wall Street. Like most things, annuities have come full circle, and are once again a popular choice to provide retirement income. The allure of a guaranteed stream of income in today’s turbulent market when many investors are reevaluating how much risk they are willing to take with their investments have made annuities popular once again.

What Is an Annuity?

An annuity is an insurance product that pays out a steady stream of income every month, quarter or year and is primarily used as a retirement product in financial planning. An investor pays a large lump sum to an insurance company in exchange for guaranteed income either for a set number of years or for the retiree’s entire life until death. Annuities can come in all types of flavors, payout schedules, fixed or variable and a host of other factors that an investor can choose from.

The Benefits of Annuities

One of the great benefits of annuities is that most investors opt for the type of annuity that will pay them a monthly stream of income for the rest of their lives. This significantly reduces the risk that a retiree will outlive the amount of money that they have saved in their retirement nest egg. While annuities will not usually comprise the entire retirement portfolio, it can be used in conjunction with other investment products and pensions and will allow investors the ability to guarantee a certain percentage of income during retirement.

Annuities also permit the retiree to receive a fixed sum of income each payment period regardless of what the overall stock market is doing. Insurance companies invest the lump sum payments in relatively safe investments that produce income for both the insurance company and the retiree with little risk to the principal amount. Annuities appeal to people with low risk tolerances.

Five Drawbacks of Annuities

While annuities are often a great investment as part of a total retirement financial plan, there are a few drawbacks to them:

  1. Annuity payments are usually not adjusted for inflation and a retiree’s purchasing power will decline over time.
  2. It is hard or nearly impossible to get your lump sum payment back once you sign up for an annuity. If allowed, annuities have a surrender charge that can be quite costly.
  3. The payment is not guaranteed or insured by the US Government the way FDIC banking deposits are. Your annuity payments are only guaranteed as long as the insurance company you have invested in stays in business and out of bankruptcy court. So, you should always conduct your own research into the health of the insurance company who is backing your annuity.
  4. Some of the fees and expenses involved in an annuity are still rather high relative to other investments, but competition in the marketplace and the sheer volume of options available to the investor have started to help fees decline. For example, the average variable annuity costs about 2.35 percent of a plan’s assets each year.
  5. Many of the people who purchase annuities are healthy, have a history of relatives living long lives in their families and they expect to live a long time in retirement themselves. Sick and unhealthy individuals tend not to invest in annuities. This characteristic actually skews the payouts to the slightly lower side for all participants to a certain degree with everyone who invests living longer.

While annuities can often be useful retirement planning investments, they can also be a lousy investment choice in portfolios for some people. Annuities have received a bad reputation because of their notoriously high fees and expenses.

In the past, many financial planners and insurance salesmen would frequently try to steer less than knowledgeable senior citizens or other people in various stages near retirement into annuities because of their high commission rates. Annuities can be a great diverse retirement tool if used in conjunction with other investment assets and through careful financial planning.

hank-coleman

Hank Coleman is the founder of Own The Dollar and several other financial websites. He is a freelance writer, entrepreneur, and professional in the government sector. Hank holds a Bachelor’s Degree in Business Administration, a Master’s in Finance, and is currently studying for his Certified Financial Planning (CFP) credentials. Be sure to follow him on Twitter.