Is an Annuity Right for You?

Implicit within the question, “Is an annuity right for you?” is the common sense realization that annuities aren’t for everyone, which is valid for just about any investment. And you are not likely to get any arguments from financial planners on that note. In the current economic turmoil and market volatility, annuities are seeing a resurgence that is leading many investors to consider them as their worries over retirement become more pronounced. So, it is a valid question that is best answered by answering a few more questions.

Have I maxed out my qualified retirement plan contributions?

Although they enjoy the same tax-deferral of earnings as qualified retirement plans, investments in annuities are made with after-tax dollars, giving qualified plans the edge for retirement savings. By simply making a contribution to a qualified plan, you are getting an instant return on your investment to the extent that you save money on the taxes you would have otherwise paid on the earned income. This tax advantage should be fully exploited before any other retirement savings vehicle is considered.

Does my income fall within the higher tax brackets?

One of the unique features of an annuity is the tax deferral of earnings allowed under the Internal Revenue Code. Investors in higher tax brackets benefit the most from tax deferral. High-income investors in a state such as California can find themselves in a combined state and federal tax bracket of close to 50%, meaning they would have to earn 50% more from a taxable investment to equal the return in an annuity with an equivalent yield. If your income falls within the lower tax brackets, you may do as well with a comparable taxable investment.

Do I have at least 12 years left in my retirement time horizon?

Annuities should be considered as long-term investments. This is due primarily to the provision in the annuity contract, which limits the amount of money that can be withdrawn without a fee. In most annuities, the withdrawal fee disappears between seven and 12 years into the contract. Additionally, the longer the tax deferral is allowed to work, the greater the compounding effect.

Do I have other liquid assets?

If you don’t have adequate cash available in other liquid savings or investments, you may find an annuity to be somewhat constrictive. In addition to the withdrawal fees mentioned above, annuities are governed by the Internal Revenue Code, which states that withdrawals made before the age of 59½ may be subject to a 10% penalty.

How concerned am I about outliving my retirement income?

As more people break into a cold sweat over the performance of their 401(k) plans, their attention is turning to alternative ways to enhance their financial security during retirement. As many as 70% of Baby Boomers are concerned that they will not have the resources to generate the income they need at retirement. If this keeps you awake at night, an annuity may be right for you, regardless of your tax bracket. Annuities are still the only financial instrument guaranteeing a stream of income you cannot outlive.

How concerned am I about the loss of my capital?

Many investors have been spooked by the wild market fluctuations of recent years and are growing more concerned with the return of their capital rather than the return on their capital. A lot of money has been moved out of the markets and into cash and savings. Some of it will remain there, while some of it is looking for alternatives that can possibly make it work a little harder. Annuities are becoming the new home for safe money, especially long-term, safe money, because they provide the safety of the principal as well as principal guarantees for beneficiaries.

Bottom Line

If you answered yes to all these questions, then annuities may be highly suitable for you. Annuities may be right for you if you answered yes to the first two questions and yes to at least two of the following four questions. If you answered no to the first two questions, annuities may not be appropriate now but could be considered when your financial circumstances change.

Annuities offer many unique features and benefits that most investors can enjoy. However, they do require a commitment from investors, which is why they must be evaluated completely before making an investment.