Annuities come in a variety of flavors including variable annuities, fixed rate annuities and a host of hybrid annuities that combine several facets of both variable and fixed rate annuities. Annuities are generally sold by well-intentioned insurance agents, not investment professionals. But there are many problems with annuities, and some profound shortcomings in annuity structure. From my point of view, annuities are best avoided because of these shortcomings.

 

One of the primary selling points of annuities is that the earnings accumulate on a tax-deferred basis. This means you will not pay taxes on the earnings until you take constructive receipt of your annuity money. Of course, should you decide to withdraw money from your annuity before age 65 you will face a hefty federal penalty, plus the tax on the earnings. Added together, you may pay as much as 40% of the amount you withdraw should you decide to withdraw your money before age 65.

 

Most annuities have early withdrawal penalties that range from 5 to 10 years of the initial annuity issuance. These early withdrawal penalties are in addition the federal penalties and the tax due on the gain. As you can see, early withdrawal before age 65 can be a very expensive proposition. So annuities must be looked at as very long-term retirement investments, and not money readily available in the event of an unforeseen emergency.

 

But there are more fees included in your annuity. Variable annuities carry a management fee that is usually about 1% of the total. There are also mortality expenses associated with annuities, which is a baffling fee because there is no actual death benefit, aside from the proceeds of the annuity, associated with the payout at the death of the annuitant. Mortality fees can range from .5% to 1%. But that’s not all, there is usually an administrative charge associated with annuities that can range from .5% to 1%. Of course, most of these charges are associated with variable annuities, which are funded with mutual funds. Of course, insurance companies hope that the superior return on mutual funds will offset the exorbitant charges associated with variable annuities. In down market years, the losses on annuities can be devastating and difficult to make up.

 

I suppose if an annuity is used properly it might be a valuable asset for a family. But the relative illiquid nature of annuities makes them a real albatross that must be held until age 65 before they can be of any value. Further, most banks will not accept annuities as collateral for a loan. Granted, there are a few that will, but my experience has been that most banks decline annuities as collateral because of the variable nature and fees associated with cashing them in.

 

Of course there is some good news, and that would be investing our money in a Roth IRA. It shares most of the characteristics of tax deferral of the annuity minus all the fees. I generally recommend this sort of investment to people when asked him I will or a because of the overwhelming advantages a Roth IRA features. One note: Roth IRAs are not tax deductible, but they are tax-deferred and can be used for a variety of purposes without withdrawal charges or federal penalties. On the other hand, you will have to pay taxes on the amounts withdrawn from your IRA.

 

In summary, I feel like annuities of all kinds are inappropriate investments for most people and they would be better served with higher-quality investment products. This may not be a popular opinion, but the facts speak for themselves.

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