Pros and Cons of AnnuitiesWhen considering a big ticket purchase like an annuity, asking a question like “What are the pros and cons of annuities” will give a high-level overview of the benefits and drawbacks of the products.

With that in mind, the primary goal of this page is to help you first decide IF an annuity should be pursued at all.

Now, because annuities are somewhat complicated products, once you understand a bit about them you’ll need to read further to decide Which One makes sense for you.  That’s the purpose of the rest of this entire web site, and throughout this page are links that will help in your journey.

Let’s get started with a look at what you can expect from each type of annuity to guide your overall decision-making process.

Pros and Cons of Annuities: Fixed Annuities

Fixed annuities pay a set rate of interest, regardless of what is happening in the market. With some fixed annuities, you can lock in a rate for a specific number of years. Because fixed annuities don’t have their return tied to equities, your principal always remains safe, and gains grow tax-deferred year over year.

As with most annuities, the growth that takes place inside of a fixed annuity is tax-deferred. This means that there is no tax on the gain in the account until the time of withdrawal. Because of this, the money that is inside of a fixed annuity can truly compound, as it is earning a return on your contributions, a return on the interest, and a return on the amount that would otherwise have been paid in tax.

As Albert Einstein famously stated: “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t … pays it.”

A fixed annuity will typically offer several alternatives for the receipt of income, which includes a lifetime ‘annuitization’ option. If lifetime income is chosen, the payout will continue for the remainder of your life, regardless of how long that may be. This can alleviate concern about running out of retirement income, even if you live well past your life expectancy.

But, while safety and guarantees are nice, there are a few fixed annuity attributes that could be considered drawbacks. First, a “tradeoff” of sorts for guaranteed return comes by way of lower interest rates.

Fixed annuities are very safe instruments and currently offer in the 3-4% yield range.  In our pervasively low-interest rate market environment, these yields make it difficult to beat future inflation. This, in turn, can have a negative impact on your future purchasing power.

Also, most annuities will impose a surrender charge if you withdraw more than 10% of the account value within the first several years after purchase. Fixed annuities are no different. Depending on the annuity, the surrender charge period could range from just a few years up to twelve or more. With that in mind, the purchase of a fixed annuity (or any annuity) should be considered a long-term commitment, and the funds that are contributed to the annuity should not have to be accessed for other needs.

Pros and Cons of Fixed Annuities

  • Fixed Annuity Benefits
  • Protection of principal
  • Guaranteed returns
  • Tax-deferred growth
  • Guaranteed income
  • Fixed Annuity Drawbacks
  • Low or limited returns
  • Limited inflation protection
  • Surrender period
  • Guaranteed income

Pros and Cons of Secondary Market Annuities

A somewhat lesser-known type of annuity are known as ‘Secondary Market Annuities‘.  These are period certain payment streams that individuals sell, and you can become the new payee of these existing and in force annuity backed payment streams.

Why would someone sell their annuity income?

There are a number of possible reasons. Most frequently, individuals who have income payments from an accident or injury receive a structured settlement which is backed by an annuity.  These settlements are often far-ranging income plans, but times change, and the plans need to change as well.  Many recipients with monthly income stream and lump sums would rather have a lump sum of cash today for paying off debt, paying health care expenses, or any other need that they may have.

Each state has consumer protection laws in place that guide the transfer of structured settlement payment rights.  DCFAnnuities.com and our related company DCF Exchange are national market leaders in the purchase and sale of structured settlement payment rights, and when you purchase a secondary market annuity, you are essentially buying the rights to contractually guaranteed payments backed by existing and in force annuities from the worlds strongest carriers.

These types of annuities tend to offer a higher yield than primary market annuities, especially those with income guarantees. But there is not an unlimited supply of secondary market annuities in the marketplace, and payment streams get purchased quickly.  To purchase, you select specific payment streams from an inventory of available cases, rather than writing one round-number check to an insurance company.

Pros and Cons of Secondary Market Annuities

  • Secondary Market Annuity Benefits
  • Potential for higher yield
  • Period certain and guaranteed income
  • Safe money allocations
  • Secondary Market Annuity Drawbacks
  • First come, first served inventory
  • Inventory may be limited at times
  • Orders may take longer to find just the right payment stream

Pros and Cons of Index Annuities

Index annuities are a somewhat “newer” entrant into the annuity marketplace. The return that you get with an index annuity is tied to an underlying market index, such as the S&P 500. These annuities are sometimes thought of as offering the best of both the fixed annuity (stable yield & principal guarantee) and the market based variable annuity (market-linked growth) worlds.

Fixed index annuities provide the opportunity to earn a higher return than a traditional fixed annuity when the market index that the index annuity is tracking performs well. But, if the index performs poorly during a given year, the annuity is simply credited with a 0%.

Because there is no negative return credited to the account, positive returns can continue to build, without having to make up for prior losses. And, as with other types of annuities, growth is tax-deferred, so it can compound over time.

In addition, available riders on index annuities offer the ability to secure lifetime income.  Depending on the contract, there are several different types of income riders that could be available, which can enhance your guaranteed income.

Some people think index annuities sound too good to be true. But while these annuities offer some nice advantages, there are also some potential drawbacks to look out for.

First, on most index annuities, the upside potential is “capped.” This means that, even if the underlying index does extremely well in a given period, the annuity will only be credited up to the amount of the cap. For example, if your index annuity has a cap of 8%, and the index that it is tracking returns 10%, the annuity will only be credited with 8%.

In addition, many of the additional bells and whistles that can enhance an index annuity – such as an income rider or long-term care waiver – will incur an annual fee or come with some other tradeoff like a longer surrender schedule. This, in turn, can end up reducing your overall return.

In addition, similar to with other annuities, if you withdraw more than a stated amount (typically 10% of the contract’s value) each year during the annuity’s surrender period, you will incur a penalty.

Overall, while index annuities offer a nice cross between safety and the opportunity for a higher return than fixed annuities, these can be fairly complex products. Plus, not all index annuities are created equal. So, before you move forward with the purchase of an index annuity, it is always recommended that you discuss your options with an annuity specialist.

Pros and Cons of Index Annuities

  • Index Annuity Benefits
  • Index-linked return
  • Protection of principal
  • Tax-deferred growth
  • Lifetime income
  • Index Annuity Drawbacks
  • Returns may be capped
  • Fees, if income riders are used
  • Surrender charges
  • Some contracts can be complicated

Pros and Cons of Immediate Annuities

Unlike deferred annuities, where your funds can grow and compound over time before they are converted to an income stream, immediate annuities will begin to pay out income immediately (or very soon after the annuity is purchased).

An immediate annuity can be a good option for retirees who are wanting to convert money from an IRA, 401(k), or other retirement savings into an ongoing income stream that is guaranteed for life. And, because immediate annuities can be set up as joint annuities, income can continue for both you and another individual such as your spouse or partner.

There are also various options and features that are available so that you can better “customize” an immediate annuity to best fit your specific needs. For instance, in order to ensure that all of the money you contribute to an immediate annuity is passed on to loved ones, you can add a death benefit. In addition, because the money that you allocate to an immediate annuity is not subject to the market, there is no worry about volatility or fluctuations.

Even with all of the great benefits that fixed annuities can offer, though, there are some possible drawbacks to be aware of. For instance, an immediate annuity has no cash value. In other words, you will receive income over time.

But these products are basically illiquid, so you can’t make a cash withdrawal and get your money back if you change your mind or in case of an emergency. In addition, depending on the annuity, if the income recipient passes away and there is no death benefit, the insurance company may retain any remaining funds.

Pros and Cons of Immediate Annuities

  • Immediate Annuity Benefits
  • Immediate income
  • Guaranteed income for life
  • Joint lifetime and period certain income options
  • Immediate Annuity Drawbacks
  • Non-reversable (once income is started)
  • No cash value / illiquid
  • Not flexible / No withdrawal control

Variable Annuities

Variable annuities offer investors the opportunity to earn a higher return, based on how underlying investments like stocks and mutual funds perform. When these investments perform well, you may see a nice gain to your annuity contract. On the other hand, if the market drops, there is the risk of loss.

Growth in the account is allowed to compound tax-deferred, which can make variable annuities a viable alternative for continuing to make tax-advantaged investments, even if you have already “maxed out” IRA and/or retirement plan contributions for the year.

Although variable annuities do offer some guarantees as it pertains to income, how exactly these guarantees work can vary from one insurer to another. Typically, though, the offering insurance company will allow you to withdraw a certain amount of money each year for the remainder of your lifetime – even if the underlying investment options lose value.

Like fixed annuities, variable annuities will typically impose a surrender fee if you withdraw “too much” money, or you surrender the contract, before a certain amount of time has elapsed. So here again, any type of annuity should be considered a long-term endeavor.

One of the even bigger drawbacks with variable annuities, though, is the fees that are charged. Even though you’ll find at least some fees with any type of annuity, variable annuities tend to be the biggest culprit.

That’s because you can find yourself paying an annual administrative fee, along with additional investment management fees from the mutual funds in the account. Plus, if the annuity has a death benefit (and many variable annuities do), mortality and expense fees will also apply. All of these fees that are charged with variable annuities can end up affecting your overall return.

Pros and Cons of Variable Annuities

  • Variable Annuity Benefits
  • Opportunity for a higher return
  • Tax-deferred growth
  • Income generation / guarantees
  • Variable Annuity Drawbacks
  • Market risk
  • Fees, and more fees
  • Surrender charge

Is an Annuity Right for You?

As with most any financial product, there can be benefits and drawbacks with regard to purchasing annuities. And, because all financial situations and needs are different, an annuity may or may not be right for you.

With so many different types of annuities available in the market today, it could be that a certain type of annuity may fit well in your portfolio. Before moving forward with an annuity purchase, though, it can be beneficial to answer a few key questions that can help you in determining whether or not an annuity may be a good option in your overall financial plan.

Determine if an Annuity is Right for You

At DCFAnnuities, we take the time to analyze your situation to help you decide if a particular annuity is right for you, and help you determine what you can expect from the annuity if you decide to add this type of financial vehicle to your retirement planning and income strategy. Contact DCFAnnuities for more information on the steps you need to take before committing to an annuity.