Annuity Hazards To Avoid
There are many fixed annuity hazards to avoid when considering a purchase. They include purchasing an annuity with funds you may need for an emergency, or being too young to purchase an annuity.
The most common fixed annuity hazards:
- Annuities Are Not Short-Term: Don’t purchase a fixed annuity with money you may need immediate access to. Your premium is safe, but early withdrawals may be subject to fees.
- Buying An Annuity Too Young: In most cases, surrendering out an annuity before the age of 59.5 will be subject to a 10% penalty from the IRS. Most who purchase annuities are already in their 50s.
- Shorter-Than-Expected Guarantee: Many fixed annuities have an interest rate that may change over time. When purchasing an annuity, make sure you know how long the rate is guaranteed.
- Understanding Withdrawal Charges: Early withdrawals from a fixed annuity may incur a surrender charge. Make sure you ask what percentage you can take out in free withdrawals.
Don’t Use Annuities As Short-Term Investments
One of the main fixed annuity hazards to avoid is purchasing an annuity with funds that you’ll potentially need access to in the event of an emergency. The penalty for surrendering an annuity early will decrease over time. It may start out at around 10%, but in the last few years of the contract it would be down to 1%-2%. Annuities are designed to be retirement savings vehicles much like a 401(k) and should not be considered a short-term investment. Because they aren’t as liquid as mutual funds or money market accounts, you should only invest retirement savings.
If you purchase an immediate fixed annuity you’ll begin to receive a guaranteed monthly income right away and the payment amount typically will not change over time. Keep in mind that the total amount you invest will not be available as a lump sum, so just make sure you are comfortable with the payment amount before the purchase. You’ll want to get a rate quote for your immediate fixed annuity and calculate the monthly payouts.
Avoid Annuities If You Are Too Young
Because investors are not taxed on the interest they receive each year with an annuity, the IRS imposes a 10% tax anytime funds from an annuity are accessed before the annuitant reaches 59.5. Using an annuity to fund a child’s college education would not be suitable, assuming the funds were needed before reaching the age requirement. Be sure to plan your annuity such that you’re over 60 when it comes time to collect.
A fixed annuity should be thought of as a 401(k), which too imposes penalties for early withdrawal. Think of it not as a penalty but an incentive — the government wants to encourage you to save for retirement.
Read The Fine Print For The Guarantee
A commonly overlooked aspect of many fixed annuities is the limited extent of their guaranteed rate. Read the contract carefully to determine how long the guaranteed rate actually lasts, because it can differ from the contract term.
For example, a fixed rate annuity might advertise itself as 6% fixed for 10 years, but if you ask the agent how long the guaranteed rate lasts, he might say, “the first 5 years”. This is a common case, which means the rate could drop on year 6.
Although this limited guarantee can come as a surprise, it’s not as bad as it sounds because most annuities feature a bail out provision. The bail out is a clause in the contract that allows you to cash out, penalty-free, if the guaranteed rate ever drops below a certain rate.
Avoid Surrender Charges
Many annuities assess fees for early withdrawal beyond a specified yearly allowance. A typical withdrawal fee might start at 8% the first year and phase out to zero within 4 years. Such fees will adversely affect your returns, but on the up side, they’re easy to avoid.
As long as you don’t invest money needed to make ends meet, you won’t be prone to early withdrawal. Statistics confirm that over 75% of annuity investors don’t withdrawal early, avoiding the insurance company penalty altogether.
But let’s supposed worse comes to worse and you have a rainy day. Even then you have a buffer in the form of a yearly withdraw allowance. This allowance ranges from 5-12%, letting you withdrawal $10,000 per year on a $100,000 investment penalty-free.