Pros and Cons of Annuities - How to Evaluate Annuities

The Benefits of Annuities

Annuities offer some considerable benefits over other kinds of retirement products, especially for those not able or willing to risk losing a portion of their retirement savings.

For example, annuities can offer:

Lifetime Income – With an immediate lifetime annuity contract, you are guaranteed periodic payments for as long as you live. The "risk" of you living a long and happy life is borne by the insurance company providing the annuity.

Social Security and pensions offer a similar form of retirement income protection – but in limited dollar amounts. The only limit to the size of your periodic annuity payment is the amount of money you have to purchase an annuity now. Even better for many retirees, the older you are, the larger your monthly payments will be for the same price.

Inflation Protection – You can customize annuities to ensure that your monthly paycheck will keep pace with the cost of living. This is critically important because inflation can have a devastating effect on your assets. The downside of an add-on like inflation protection is that it will cost more – in an initial cost or in lower starting payments to begin with.

Principal Protection – One of the best features of fixed and equity indexed annuities is that the value of the annuity can be guaranteed to be at or above the amount invested. You can guarantee that you (or your heirs) will receive back at least as much money as you invested in the annuity.

Tax Efficiency – The purchase of an annuity with qualified retirement savings (401k or IRA funds) can save you money on taxes over taking a lump sum payment. You can roll-over qualified funds into a qualified annuity without any tax penalties. You only pay taxes on the income the annuity provides.

In summary, an annuity is a great way to protect your quality of life in retirement. Your retirement assets can be efficiently used to purchase guaranteed income to last as long as you need. Best of all, this income can be protected from inflation and other financial woes.

So, What are the Downsides of Annuities?

Despite the many advantages of annuities, they do have some downsides.

Not All Annuities Are Created Equal – The financial planning community views some annuities – particularly fixed annuities -- as being the ideal solution to a retiree's need for guaranteed income. Fixed annuities have a very good reputation. However, other annuity products are viewed as "snake oil" – an unnecessary and expensive product. It is very important that you understand the various features and terms that are applied to annuities.

Lower Returns on Your Investment - In return for the retirement income certainty provided by fixed annuities or equity indexed annuities you forgo the opportunity to make bigger returns by investing your money in assets that fluctuate in value, like stocks. A fixed annuity is considered to be a safe and conservative investment but this means that you will not see the possible gains (and losses) of a riskier investment – like the stock market.

Inflexible - Annuities are also typically less flexible than other retirement options – once you purchase an annuity contract your capital is tied up in the annuity, so you don't have access to that lump of money.

Some retirement financial planners recommend that people reserve at least 40 percent of their retirement assets for unforeseen circumstances. Because most annuities are designed to provide steady income over time, they are not ideally suited to cover large unplanned expenses.

(However, although undesirable, if circumstances require it, there are third party companies that will exchange a lump sum payment for your fixed income payments. In this situation you will likely end up receiving less than the amount you paid for the annuity.)