Forward-thinking people understand that they could outlive their assets, so they want a plan that guarantees an income stream for life. One solution they might consider is a retirement annuity. This is an insurance product that is often funded years in advance of retirement, either by a lump sum investment or with regular payments over a number of years. While there are a number of different kinds of annuities, the basic premise is the same: a guaranteed monthly or annual income from the time you retire until your death. What could be wrong with that?
Annuities Can Have High Fees and a Big Tax Burden
In addition to a guaranteed income during retirement, annuities allow you to defer payment of income tax. However, there are also disadvantages to using a retirement annuity instead of other savings tools for retirement, including the following:
- Hefty up-front fees. Not only do you pay a commission when you set up the annuity, but you will pay an annual fee of about 2 percent. These costs are considerably higher than investment tools such as mutual funds and CDs.
- Lack of liquidity. Your money will be tied up in the annuity until your first payment, and even then, there are penalties for withdrawing more than the standard payment. If you have an emergency need for money at some point, it will cost you to get it out of the annuity.
- Higher tax rate. While annuities are tax-deferred, when you do take withdrawals, the money is taxed as ordinary income, rather than at the much lower capital gains rate. Depending on your age, it might make more sense to maximize a 401k or IRA account than to invest in an annuity.
- Complexity. There are a lot of complicated annuity products available with a variety of benefits and limitations. If you don’t understand how the annuity works, it is probably best to stay away.
If you die with money left in your annuity, it will be passed on to your named beneficiaries as a lump sum or an income stream.
Annuities as Estate Planning Tools
An annuity might make sense in certain situations, but it’s important to discuss the pros and cons with a financial advisor or estate planning attorney. The goal for retirement savings and for an estate plan is to maximize your assets and minimize fees, taxes, and penalties. When you work with the estate planning attorneys at Ross & Shoalmire, we will make sure that you understand the annuity product you already have, help you decided if an annuity is right for you, and incorporate it into your estate plan to maximize the benefit to your heirs.