What age should be considered too young or too old to purchase an annuity?
The Target Ages For An Annuity Is Between 40 and 70 years old.
Annuities have benefits and features that are geared towards one specific life event – retirement. This means that the right age for annuities is when you are retired or nearing retirement. There are stipulations within the IRS tax code that allow annuities to grow on a tax deferred basis. This means that year to year annuity gains are not subjected to income or capital gains taxes, so long as the funds remain within an annuity or some other qualified account.
This tax deferred status is beneficial because money that would otherwise be paid to the IRS stays in the account and will continue to earn interest. This can result in a substantial increase in overall yield.
The reasoning behind this special tax status is to encourage individuals to save for retirement. The trade-off to tax deferral is that the funds must remain in a qualified account until you reach the age of 59 1/2. Accessing the money before that point will trigger a 10% tax penalty, as is the case with cashing out your 401k or IRA. This is one of the main reasons you should only consider an annuity when you are at or nearing retirement.
Too Young For An Annuity
There are very few scenarios in which an annuity would be the most beneficial investment choice for someone under 40 years old. Annuities are typically longer term contracts and you can not expect the same level of returns from an annuity that you could from the stock market, real estate, or other equities.
Long Term Contracts
In addition to the 59 and a half rule discussed in the previous section, annuities tend to have longer term contracts which further limit a younger investors ability to access their funds in the event of an emergency. Most annuities have a length of five to ten years.
There are pretty severe penalties called surrender charges that are imposed on the policy in the event that funds are withdrawn before the end of the contract. The earlier you take your money out of the annuity, the higher the surrender charge will be. This should give pause to a younger person who is considering an annuity.
Annuities Prioritize Safety Over Performance
Annuities are a fantastic option when your goal is to protect your money while receiving modest growth. However, the trade off to safety is the limited upside potential. A younger person will typically be better off in an investment vehicle that offers the potential for higher gains, such as stocks or a mutual fund. When a person is in their 20s, 30s, or even 40s, they have time to make up losses caused by market corrections.
A general rule of thumb for investing is to match the percentage of “safe money” in your portfolio to your age. Meaning that a 25 year old investor would have 25% of their savings in risk averse vehicles such as cash, bonds, or CDs. By the time they reach 50 years old, around 50% of their savings would be in their safe money bucket. Using this methodology, the sweet spot for purchasing an annuity is between 55 and 65 years old.
Too Old For Annuities
There are no laws or IRS rules in place that set a maximum age limit for purchasing an annuity but insurance companies that sell annuities set their own age limits. Most companies will set the upper age limit between 75-95 years old.
Given the fact that the 10% IRS penalty for cashing out an annuity expires after 59 1/2, the determination for what is “too old” for an annuity becomes a personal choice. Annuities continue to offer safe, tax deferred growth at older ages, so as long as you have adequate funds in reserve for emergencies, annuities are a viable option at any age in retirement.