Let’s talk about the Pros and Cons of Annuities.

Are Annuities Good or Bad?

Annuities can be a great passive way to build your own personal pension plan.  There are ways to grow your money safely and more aggressive annuity structures that allow for loss but with much higher potential gains.

Annuity Definition

If you’ve ever asked what is an annuity you could pick up the book Annuities for Dummies.  It’s thorough and easy to understand.  It’s fairly simple to define annuity.  It’s basically a traditionally safe way to create a self-funded pension plan.

It goes like this.  You give the insurance company a sum of money and in return they will guarantee a certain payback period with a specific monthly amount that will start at a predetermined time.  There are many different types of annuities and almost just as many companies that offer annuities so it’s key to truly understand the annuity you are choosing and possibly even more important is to understand the financial strength of the company that is providing the annuity.  The reason being is that you are giving your money to a company.  A company can go bankrupt and everyone who gave their money to that company could have dramatic losses which would be extremely detrimental to your quality of life.  Especially since most people involved with annuities are 40 years of age and older.  The good news is that annuity defaults are 0 but to protect yourself it may make sense to go with a company with a long track record of fiscal soundness.  Although we don’t recommend specific companies for annuities it may be beneficial for you to check out a Vanguard annuity.  They have been around for a long time.

How To Choose An Annuity

Most potential investors do seek advice from brokers and financial advisers as they may find the area a complex one to delve into.  There are a wide variety of annuities available, which are all designed to pay out money after a certain amount of time, or when an investor or one of their relatives reach a certain age or some other predetermined benchmark.  It could be immediate as well.  Generally annuities are taken out to cover retirement yet they could also be used for other purposes such as when children or grandchildren reach maturity, go to college, or get married.

Broker Due Diligence

Due to the complexity of some of these annuity plans they tend to be sold by brokers and financial advisers. In most countries it is a legal requirement that whoever sells or tries to sell you these investments let you know if they represent certain companies, and if receive commission from these companies every time they make a sale for them.  Much of the poor reputation surrounding annuities stems from potential investors not been entirely convinced about the accuracy or indeed the sincerity of the advice given to them by their financial advisers.  With brokers and financial advisors having to disclose they make a commission that level of mistrust should decline.  Investors should always keep in mind that depending on what kind of annuity they sign up to that that he value of their investments can decrease or increase.  That is were studying the pros and cons of these plans comes in handy, the more secure ones protect your investment better, whilst the riskier ones may give you a higher rate of return.

Whatever the pros and cons of annuities they still attract a high number of investors.  Indeed only property and precious metals or gems attract more investment than annuities do.  Therefore enough people must trust the underlying concept enough to be willing enough to invest.

There are three basic types of annuities, which are designed to help investors finding themselves in different situations.  These types are fixed, index and variable annuities.  They all have pros and cons as discussed in the following paragraphs.

Fixed Annuity

Conservative Strategy

There are certainly pros to taking out a fixed annuity.  Firstly you will know exactly how much money you will receive once the plan matures.  This means that you plan ahead for your future retirement, and budget for the money, which you will definitely receive.  This is important as you can think getting all of the things that you will require for a comfortable standard of living once you are a pensioner.  As the amount is fixed you do not have to worry about having a shortfall that could unexpectedly ruin your retirement plans.  You can decide on the amount of cash which you know you could life off when you chose, which plan to go with.

There are however cons if you pick a fixed rate annuity.  When the policy is taken out the money received at the end of it’s term may seem a really useful sum.  However by the time the policy matures the amount seems to be inadequate for a variety of possible reasons.  First, the value of your investment could be whittled away by increases in the inflation rate.  The longer the policy is held for then the greater the risk that inflation will have reduced the worth of your annuity.  It could also have to pay for things, which were not originally envisioned as well, such as the costs of caring for you, or the cost of medical treatment if you are afflicted with age related health conditions.

Fixed Index Annuity 

Small risk/Medium Reward Strategy

The pros of fixed index linked annuities relate to the fact that you typically have guarantees on percentage return on your money but you also have the ability to capture gains from the stock market.

The main cons of the fixed index linked annuity is that by choosing this you may have a lower guarantee than you would with a fixed annuity.  You will also not be able to predict how much exactly the policy is worth until it has matured for you.  The key thing is trying to balance having an investment that holds it’s worth against losing predictability as to how much the final payout is worth.

Variable Annuity

More Risk/Most Reward Strategy

There is one notable pro of taking out a variable rate annuity, that is the prospect of having a matured policy, which is worth substantially more money for you than a fixed or fixed index annuity.  The traders used by your brokers take more risks in how your capital is invested.  If their gambles succeed you have more money to retire on.  In many of these policies you are able to direct the fund where to invest your money.

The main con of a variable rate policy is the other side of the same coin.  Should the investment gambles fail then you are left with a final payout that is worth less than the premiums you paid into the policy.

In conclusion, hopefully you have a better understanding to the question are annuities good or bad. They can be a very beneficial component of one’s financial life. There are alternatives out there that may have a much higher return on principal but typically come with much more risk so it really all depends on you, your goals and risk tolerance.

To your everlasting wealth!