8 Reasons Not to Buy an Annuity

2. Inadequate Liquid Savings

While an annuity might provide a good addition to a client’s overall retirement income planning, this must be viewed in context. If your client would struggle to come up with the money for the contract premiums, the annuity might not be the best option for them, at least at this time. For example, if they would need to tap their emergency fund or other savings to cover the premiums, this could leave them financially vulnerable in the event of an unforeseen illness, job loss or other type of emergency situation.

While an annuity of some type might ultimately be a good idea for this client at some point in time, the purchase of the annuity needs to be viewed within the client’s overall financial situation.

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3. Shorter Life Expectancy

A client with a relatively short life expectancy may not live long enough to reap the full benefits of the guaranteed lifetime income stream offered by an annuity. While most contracts have beneficiary options and/or annuitization options that can cover a spouse or other beneficiary, the client’s desire to leave an estate to their loved ones might be better served by other strategies.

Other strategies might include the purchase of additional life insurance or building up their balances in both taxable and retirement investment accounts. If feasible for the client, building a balance in Roth accounts might be a good planning strategy. If the five-year rule is met by your client, Roth IRAs can be passed tax-free to beneficiaries making them a powerful estate planning tool, especially in the case of non-spousal beneficiaries.

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4. Surrender Charges and Taxes

Many annuities carry a surrender charge that might last for as long as 10 years. If your client might need to withdraw some of their premium dollars from the annuity during that period, the surrender charges, which can be as high as 10% of the withdrawn amount, will further reduce the value of the annuity

If your client needs cash from the contract, they will need to pay taxes on the funds withdrawn to the extent they tap into earnings within the contract. Withdrawals are made on a last-in, first-out basis, virtually ensuring this will be the case with a non-qualified annuity. If the client is younger than age 59 ½, they will also be subject to an early withdrawal penalty.

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5. Limited Growth Potential

If your client needs growth from their retirement savings, an annuity might not be their best option. Some types of annuities do offer higher levels of growth than others, such as indexed annuities and variable annuities.

Indexed annuities usually cap the amount of any gains in the index that the contract owner can participate in. Many variable annuity contracts offer high-cost annuity sub-accounts as investment options.

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6. Inflation

Many annuities do not earn returns that keep pace with inflation. This can especially be true with many fixed and fixed indexed annuities. A variable annuity may offer your client a better chance to keep pace with inflation.

Some annuities offer an inflation rider to help contract owners keep pace with inflation. These riders generally come with a cost that can reduce overall returns from the contract. There may also be limits on the extent to which the rider matches inflation. Often, the inflation or cost-of-living adjustment (COLA) rider will cause the annuity benefit to be reduced with the inflation benefit applied to that lower benefit amount. Be sure to understand the limits of any inflation or COLA rider and the impact of the rider’s cost on contract benefits.

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7. High Fees and Expenses

Many annuities come with high embedded fees and expenses. The most common of these is the mortality and expense (M&E) fee in most contracts. Additional expenses may include agent commissions and the cost of various contract riders that may be needed for the annuity to cover your client’s needs.

Some common riders include those offering death benefits, long-term care coverage, minimum annuity payments and inflation protection. None of these riders are necessarily bad, but there may be less expensive ways for your client to accomplish the same goals outside of an annuity. Additionally, the application of a rider to the contract’s benefit may reduce your client’s annuity payments below what they expected.

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8. Estate Planning Objectives

Assets such as stocks, bonds, mutual funds and ETFs left to heirs may be eligible for a step-up in basis. This means that the client’s heirs will be able to use the value of the holdings on the date of death of the account holder as their cost basis in the inherited assets.

While annuities do offer options for the contract owner’s heirs to receive a benefit upon the owner’s death, beneficiaries generally will be taxed on the difference between the contract cost basis and the contract value they receive. These gains are taxed as ordinary income. Depending upon your client’s estate planning objectives and other assets available, an annuity may or may not be a good idea.

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