Debunking Common Annuity Myths: What You Really Need To Know

Most financial products are misunderstood, and many come with common myths. However, if you learn how annuities work and who they are best for, you could open up another investment opportunity.

Despite annuities being coined as “bad,” they have improved throughout the years, according to Fidelity Investments.

Some common myths about annuities include the beliefs that they’re bad investments, have hidden fees or lock you out of your money forever. There are also concerns about inflation, insurance company stability and the idea that annuities are only for retirees.

Learn the truth behind each myth below.

One reason that people avoid annuities is that they believe they are “bad,” especially for their taxes. However, fixed annuities typically have no annual IRS contribution limits and are tax-deferred.

Annuities can offer valuable income protection when matched with the right financial goals. You should always speak with a professional before making any financial or investment decisions.

While some annuities have fees, they’re usually disclosed and tied to optional benefits like lifetime income or long-term care coverage.

If you’re ever curious about what fees you might be charged, read through your annuity contract before signing. This is also another place where a financial advisor could help. You can also negotiate the fees in your contract.

You will not lose access to all your money until retirement. Most annuity products will allow for partial withdrawals. However, if you take a withdrawal before you’re supposed to, it could result in additional fees.

Not only can early withdrawals from certain annuity products be subject to income tax, there can also be a 10% penalty with the IRS if taken before age 59 ½ and charges that are outlined in your contract.

Some contracts also offer flexible options for before and after you start receiving payments.

This is not the case for some types of annuities. Variable annuities, for example, are tied to the performance of the market. Registered index-linked annuities (RILAs) are also based on market index values, but they also offer a bit of protection from any market volatility.

According to Principal, even income annuities, which usually have a fixed return rate, could include step-ups or other features that can help build your future guaranteed income.

However, your growth potential and the benefits you receive will depend on the type of annuity you choose. It will also rely on the details of your annuity contract, including fees and cap rates. Any fees and rates could limit an annuity’s performance, but can be worth it for the other benefits.

State guaranty associations and strong financial regulations provide consumer protection even if an insurer fails. This is why it is important to compare insurance companies and check their financial strength through Moody’s, A&M Best, Standard & Poor’s, and more.

It is common for people to believe that annuities are solely for those who have already retired. However, if you have maxed your contributions to an employer savings plan or an employer IRA, you can use deferred annuities to help build your wealth, according to Fidelity Investments.

Deferred annuities allow you to grow your investment tax-deferred, which can then be turned into an income stream in the future. There are two types of annuities, including:

The vice president at Fidelity Investments, Stefne Lynch, said, “It’s important with any annuity product to make sure you’re investing with a highly-rated company. A good way to tell is by checking with a rating agency like Standard & Poor’s or Moody’s.”

The goal of all annuities is to take a chunk of money that you invest and turn it into guaranteed income in the future. But there are different types of annuities, and it is important to understand the differences.

This type of annuity allows you to make an investment now and start taking payments in the future. You can later take payments as one lump sum or periodic payments.

Deferred annuities can allow younger individuals to have another tax-advantaged way to save before retirement. It can be beneficial for those who have maxed out other contributions to other retirement accounts, like an employer-sponsored IRA.

With an immediate annuity, you will start to receive payments as soon as it is purchased. Typically, a lump-sum payment will be made to the issuing insurance company and a steady stream of income is given for a specific amount of time.

This is best for those who are nearing retirement age and already have a lot of funds for retirement.

Fixed annuities will give you a specific return rate, with the insurance company taking on all the risk. The principal growth will be based on a specific index, like the Dow Jones, which will allow for market gains like veritable annuities.

These annuities also have a guaranteed minimum return, but the returns are normally capped. This means, if the index does well over a specific amount of time, you might not be able to fully benefit from all of the gains.

A fixed index annuity does give you the potential of earning higher returns when compared to fixed annuities. But they also still give guaranteed growth and protection against some declines in the market.

A variable annuity will let you invest in several different options, like bonds and mutual funds. Your return rate will not be fixed and will depend on the performance of whatever investment options you choose.

Since you have the responsibility of choosing what investments your annuity will go toward, you take on all the risk instead of the insurance company. While this could lead to you having a better chance of higher gains, your value could also drastically decrease.

Registered index-linked annuities are newer to the annuity game. These give you control over any gains or risks. This is typically for investors who are willing to accept some loss. The higher the risk that is taken with these annuities, the higher the potential of large gains.

However, gains and losses are capped on RILAs, so they don’t have as much growth potential as variable annuities (but they do have a lower risk factor).

Annuities can provide guaranteed lifetime income, tax deferral, principal protection, and customizable contract options. According to Guardian Life, the benefits of annuities include:

Fees on your annuity can depend on which product you choose, while risk levels will depend on whether it is market-linked or fixed.

Variable annuities, for example, could have higher fees, income caps and surrender charges. Options like the guaranteed income stream could attract rollover investors, but it can get expensive over a long period of time, according to Kiplinger.

The cost of any guarantees or fees will vary depending on the insurance company you choose. These are some of the fees you should look out for, according to Kiplinger:

Your annuity can only be as stable as the insurance company that is issuing it. It is important that an insurance company has a strong financial background and is able to meet any financial obligations to policyholders.

You can use organizations like AM Best, Standard & Poor’s, Moody’s and Fitch Ratings to find a company’s financial score. By choosing a highly-rated insurer and understanding any protections your state backs, you can help safeguard your investment.

An annuity may be a good fit if you value income guarantees, principal protection or tax-deferred growth in retirement. However, you should always speak with a financial advisor about your investment options.

A professional will be able to let you know if annuities are the best option for your financial situation. They can also help you choose which annuity type would be the best.

Editor Norah Layne contributed to this article.