On the surface, income annuities seem like a pretty good deal. You’re going to get a guaranteed income for life. The only problem is that not every income annuity is clear and precise in how it works. There are many products on the market today that are massive income generators for insurance companies and their representatives, so it may not always be a first-choice investment solution. Are you thinking about whether or not income annuities make sense for your investment portfolio? Then here are the key points to consider in the income annuities pros and cons.
What Are the Pros of Income Annuities?
1. You can make a ton of cash if you reach old age.
Annuities are moneymakers for those individuals who are able to reach the upper levels of senior living. As you get older, the mortality credits get bigger. This means when you purchase a lifetime income annuity, you’re making the bet that you’ll live longer than the other people in your fund. If you do, your return could be huge.
2. The earnings are tax-deferred.
If you’re making money with an income annuity and it stays in the account without a distribution, then the earnings are tax-deferred. They are tax-free, but if there is zero incoming income, then there’s a good chance that the capital gains taxes could be 0% when a distribution is taken. Most capital gains tax rates are still lower than the higher progressive income tax bracket rates, however, so it is still a pretty good deal.
3. Any income earned from an annuity can be given to heirs.
Unless there is a tax-deferred balance remaining in an income annuity, the only tax responsibilities that heirs would have to obtaining the money in this account would be interest taxation. For this reason, if the qualified account was started as a Roth IRA, which uses post-tax dollars for funding, then there would be little tax responsibility [if any] on the balance.
4. Payments can begin immediately.
There are different types of annuities from which to choose so that your financial needs can be met. Some start payments right away, which are immediate annuities. Others have deferred payments that can be issued quarterly or yearly. Some only pay at the end of the term and provide a lump sum of interest and available mortality credits. You can also purchase fixed-rate annuities, which pay out the same amount no matter what happens with the fund in the investment market.
5. The investment into the annuity is protected.
If you purchase a fixed annuity, the money is 100% safe. You’ll always receive your money back with a little bit of a return. Should the insurance company go out of business for some reason, then every state in the US offers a guarantee association that typically offers up to at least $150,000 of coverage. Some states offer up to $300,000 in certain circumstances.
6. It’s a fairly easy account to maintain.
Once you start receiving income, your annuity basically works on its own to provide you with the cash you need. You don’t have to hover over it or worry about your stocks or bonds as other retirement accounts sometimes require. Just find the product that makes the most sense for your income, follow the rules, and start collecting.
What Are the Cons of Income Annuities?
1. You might not receive anything back.
In basic terms, an income annuity is a bet on how long you’re going to live. Let’s say that 100 people invest the same amount of money and are placed into the same age-group annuity. Payout of the annuity happens when you reach the age of 80 for this product. Your returns are based on the mortality credits that are issued. If all 100 people live, then you only receive interest back. If 24 people die, then you get interest plus your share of those other 24 annuity investments.
2. It’s not a young person’s investment option.
When you’re young, it can be safely assumed that most, if not all, individuals in an investment group are going to be alive at the end of an investment period. That’s true even if the investment period is 10-15 years. This means the mortality credits that could be received are virtually zero. This means it is typically not worthwhile to make this sort of investment until the age of 75 when the returns become much greater.
3. Many riders are added that may not ever be needed.
Although this is generally treated as an income product, it can’t be forgotten that this is really an insurance product. Because of this, there are usually riders included with an annuity to help protect people from certain life events. A nursing home ride, for example, can cover the costs of long-term care. A terminal illness rider may allow you to transfer or access money without surrender fees or penalties.
4. It creates a loss of liquidity for retirees.
Ultimately income annuities tend to play on the fears that retirees have in that they’ll run out of money. The offer of guaranteed income for life is a pretty good offer to relieve those fears. The only problem is that it may take a $100,000 investment to get involved with the annuity and the return may be as low as $1,000 per month when taken immediately. At $12,000 per year, you’ll need to live 9-10 years at minimum to get your money back.
5. There are early withdrawal penalties that are similar to 401k accounts or IRAs.
The IRS is going to charge you a 10% penalty on any withdrawals that occur before the age of 59.5 that don’t involve the actual principal amount of the annuity. If an emergency happens and you’ve invested into an annuity early, you’re stuck in a Catch-22. You either lessen the gains you can experience or you pay a penalty on your profits plus capital gains taxes.
6. Other retirement product can often outperform income annuities.
As with any financial product, it is important to have a diversified income stream to make sure there is enough cash available. This is never more true than during the retirement years. Many investors make the mistake of putting all of their available cash into this product and that can be costly for the entire family.
These income annuities pros and cons must be evaluated before an investment is made because this product is not right for everyone. If you’re in good health and have a family history of living well into your 90s, then it could be a great investment. If you only expect to live to the age of 75-80, however, and your health has always been a little questionable, then it may not be the best choice. Evaluate these key points and then make the decision that is right for you.