Annuities are advertised as a solution for providing consistent retirement income for life. When you buy an annuity from an insurance company, the company invests your money and pays you regular payments.
Guaranteed retirement income can provide greater peace of mind, but annuities come with several major drawbacks.
Income From Annuities Get Taxed as Ordinary Income
The government taxes income from annuities as ordinary income, which is typically taxed a higher percentage compared to the capital gains from investment income.
Your contributions grow tax-deferred. However, you need to pay taxes on your payments. If you also receive retirement income from a 401(k) and a traditional IRA, the payments may place you in a higher tax bracket.
Insurance Companies Do Not Adjust for Inflation
Most annuities are not adjusted for inflation, which decreases their value over time. If you begin receiving payments from the annuity at 65, you will receive the same amount at age 85.
Prices of consumer goods and services increased about 42% between 2000 and 2017. In another two decades, the money that you receive now from an annuity will hold less value as the cost of living rises.
A diversified portfolio with a mixture of stocks and fixed-income investments can easily earn interest to keep up with the annual rate of inflation while offering the potential for a bigger return.
Annuities Come with Large Fees and Penalties
401(k)s, individual retirement accounts, and standard brokerage accounts often come with minimal fees or zero fees. Annuities include a large initial fee. Some insurance companies charge up to 10% of the lump sum that you deposit.
Along with the initial fee, insurance companies may charge management fees. The annual fees for managing the annuity averages about 1% of the value of the policy each year. The charges limit your retirement income.
Annuities Are Not the best option for Retirement Accounts
Some types of annuities do not provide guaranteed income. As with other investments, some annuities come with a greater risk of financial losses. If the value of the annuity decreases, you may receive less income during retirement.
The most common types of annuities include deferred variable and deferred fixed annuities. The value of a variable annuity can vary based on the performance of the investments. Fixed annuities offer a guaranteed rate of return for a fixed number of years, which carries less risk.
Instead of annuities, you may find a safer way to grow retirement income, such as an individual retirement account (IRA). Roth IRAs, traditional IRAs, and gold IRAs all provide separate advantages that may suit your retirement goals.