Are Annuities Safe?

Planning for retirement is crucial to ensuring your comfort and quality of life when the time comes and you can no longer make money for yourself. If you’ve been planning your retirement for a while, you’ve probably heard of annuities.

Annuities are thought to be one of the safest insurance products by many financial experts and retirement planners, and there are many reasons to back up this claim.

However, annuities are still susceptible to risks or losses. If you’re wondering about the security of annuities and how it will affect you, then keep reading.

The Risks and Disadvantages Posed by Annuities

Like any other insurance or investment tool, annuities possess inherent risks, and these are:

Credit Risk

Credit risks refer to the risk that an insurance provider may fail to pay out the full amount of your annuity. This can happen if the insurance company can’t pay its bills or goes out of business.  Although this risk is rare, it can happen, which is why you should work with an experienced financial professional who can help you understand the credit quality of each annuity company. 

Purchasing Power Risk

Inflation is the primary influence on the purchasing power risk, or the risk of your annuity’s value depreciating due to inflation. Depending on how your annuity is set up, you may not be able to get back any money you lost because of inflation.

Liquidity Risk

Annuities are meant to be held for an extended period, usually between 3 and 20  years or more. This means that you may not have access to your funds when you need them most, or even worse, lose a portion of their value if you withdraw the money early.

Surrender Risk

In insurance terms, surrender means you are giving up the policy and any guaranteed returns. When you give up your annuity, you will have to pay a big penalty fee or lose out on any possible gains you could have made by keeping the policy until it matures.

Risk of Death

Another lesser-known risk of annuities is the risk of death. Annuities are the opposite of most life insurance, in which the payouts stop when the policyholder dies. If you die before receiving your total payout amount from an annuity, in some annuity contracts, any remaining funds are forfeited and are not distributed to your heirs. It’s important to work with a professional to understand this potential risk and if it doesn’t meet your needs, ensure your annuity does not have this feature.

Advantages of Investing in Annuities

Annuities provide some of the most generous benefits, including:

  • Tax-deferred savings: One of the best things about investing in annuities is that you can put off paying taxes on any earnings for a certain amount of time. This means that the interest rate or returns you receive from your annuity won’t be taxed until you withdraw money.
  • Guaranteed income (1): Undeniably, the most attractive benefit of annuities is the guarantee of receiving an income stream through the length of the policy, and if structured properly for the rest of your life regardless of how long you live.  This means you can enjoy financial security and stability throughout your golden age for as long as you live. 
  • Flexible contribution: Annuities allow you to choose how much money you want to contribute and when.

There’s no way to get around the fact that annuities come with risks and drawbacks, but the pros far outweigh the cons. If you’re looking for a safe and secure retirement plan, you should consider purchasing an annuity.

The Effects of Recession on Annuities

Economic recessions do not necessarily make annuities riskier. But this could make the risks that come with annuities worse, which could affect your annuity indirectly.

For example, a big economic crash could make it hard for you to pay your annuity premiums, which would raise your credit risk. A recession could also put you in debt, which would make it hard to pay your annuity premiums and put you at risk of giving up your annuity.

An economic recession also risks insurance providers’ ability to fulfill their financial obligations. This could leave you without the total payout amount on your annuity and put you in a more vulnerable position.

It’s also important to note that certain types of annuities, such as variable and market-value-dependent annuities, are highly reliant on the stock market. If the stock market isn’t doing well, the returns or income you get from your annuities may go down.

Even though a recession doesn’t have a direct effect on annuities, it’s important to know the risks and find ways to reduce them. Before you sign a contract, you should also look into the terms and conditions of your annuity. Doing so can ensure that you will be protected if an economic recession occurs.

Ways to Manage Risks Presented by Annuities

Knowing all of these makes you aware that purchasing  annuities, no matter how “safe” they seem, still comes with risks that must be managed and minimized. Here are some ways you can do that:

Don’t Be Influenced by External Pressures

One of the most obvious ways to deal with surrender risks is to not let outside pressures affect you. Online news headlines are meant to incite emotion and grab your attention, but don’t be swayed by them.

Instead, decide whether or not to purchase an annuity based on how well you know and understand the current economy.

As mentioned, annuities are not directly affected by economic recessions, but if you think you’ll have a hard time meeting the premiums, it’s best to speak with a licensed agent and weigh your options.

Diversify Your Retirement Portfolio

Diversifying your portfolio is an age-old trick to minimize risk and maximize returns.

Having a balanced mix of investments and annuities can help you manage portfolio risk.

Many financial professionals believe it would be best to spread your investment across different asset classes, including stocks, bonds, mutual funds, and cash equivalents such as treasury bills and money market accounts. You may also purchase another type of annuity, such as a fixed one, to further diversify your portfolio. 

Choose the Correct Annuity Provider

The risk of insolvency is out of your control once you invest your money. To avoid this risk, it’s best to research and compare annuity providers before committing.

As a general rule of thumb, you should look for an insurer with strong financial ratings and good customer feedback. You can also consult a safe wealth expert to get their opinion on the various companies available.

You can always refer to the guidelines published by credit rating agencies, such as AM Best and Standard & Poor’s, to guide your decision-making.

Understand How Interest Works and Its Implications in Your Annuities

Annuities gain money through interest, so understanding how interest rates work is crucial. The principal amount never changes if you’re investing in a fixed annuity. However, with variable annuities, your principal can vary depending on stock market performance.

Understanding how the current interest-rate environment works allows you to identify which type of annuity is best for you and determine how much money you should save to reach your financial goals.

Annuities vs. Other Types of Investments

Knowing how annuities compare to other types of investment allows you to make a more informed decision when choosing the right kind of financial vehicle for you.

Annuity vs. Life Insurance

Many often compare life insurance and annuities as they are seen as opposites. Life insurance provides a lump sum to beneficiaries upon the policyholder’s death, while annuities provide a steady income throughout retirement.

Both are tax-deferred plans, meaning you don’t have to pay taxes on the money gained until it is withdrawn.

If you want to make sure that your income in retirement is steady and reliable, an annuity is a good choice. Life insurance, on the other hand, is good if you want to make sure that your family will be safe after you die.

Annuity vs. IRA

An IRA, or individual retirement account, is another popular form of retirement savings. IRAs are investment accounts that allow you to hold stocks, bonds, and mutual funds, among other things. Because of this characteristic, IRAs are not considered assets.

In contrast, annuities are insurance products that provide a guaranteed(1) income stream, making them an asset. You can use annuities to secure your retirement income, while an IRA will give you the potential to earn more money in the stock market.

Annuity vs. Mutual Funds

Mutual funds are defined as a collection of investments, such as stocks and bonds. They are run by a financial advisor or a group of financial advisors who invest in a variety of assets to make money for their investors.

Unlike annuities, the money you earn in mutual funds is not tax-deferred but taxed every year based on the gains or losses. While mutual funds can be riskier than annuities, they offer higher return potential and are more liquid, but can suffer greater loses.

Annuity vs. Pension Plan

An annuity and pension plan share many similarities, such as the regular payout promise and tax-deferred status. However, the difference between them lies in who pays for it.

A pension plan is set up by an employer and funded entirely by them, while annuities are usually self-funded. An annuity also allows you to choose how your money will be invested.

On the other hand, most pension plans are either defined-contribution or defined-benefit, so you don’t have much choice.

Annuity vs. CD

A CD or certificate of deposit and an annuity are great options if you’re looking for a stable and low-risk retirement investment. A CD is an FDIC-insured deposit account that allows you to lock in a fixed interest rate for a certain period of time.

On the other hand, annuities are contracts sold by insurance companies that guarantee a certain amount of return on your investment. An annuity pays out income during retirement and offers more flexibility than a CD when making contributions.

CDs are ideal for short- to medium-term investments, while annuities are best suited for long-term retirement savings.

Consider These Before Purchasing an Annuity

Purchasing  an annuity is a thoughtful process, and there are many factors you should consider before putting your money into any type of investment or insurance product. We outlined some of the factors you may want to examine before signing an annuity contract:

Different Types of Annuities

Annuities exist in various types, ranging from immediate to deferred or fixed to variable. Knowing which type of annuity is right for your needs and goals is essential in making a sound decision. Identifying the best annuity option for you requires speaking with a knowledgeable financial advisor.

What Level of Risks Are You Willing To Take?

Annuities are generally considered low-risk, though some types involve higher risks, such as variable annuities. In general, low-risk typically equates to lower returns, and this logic applies across different types of investments.

You should accept that once you receive your annuity payout, you may not receive a higher return than what was initially promised when you purchased the annuity.

Choosing the Right Annuity Provider

As mentioned, choosing the right annuity provider is essential, and you should evaluate its reputation, performance history, customer service, and fees. Also make sure to ask about any surrender charges and the company’s rating with any independent rating agencies like A.M Best or Standard & Poor’s.

Any Investment Comes With Risks

Every investment comes with a risk, even the safest of them all. This is the harsh truth that you must learn to accept as someone preparing for retirement. However, every risk is manageable and can be minimized with proper planning and decision-making.

Purchasing an annuity can provide you with a steady stream of income during retirement, and it may also offer tax advantages, depending on the type of annuity you choose. Still, it’s essential to understand the potential risks associated with investing your hard-earned money in an annuity.

Speaking with an experienced financial advisor is the best way to save yourself from these inherent risks of investing in an annuity. They can help you evaluate the best option for your retirement needs and create a tailored financial plan to ensure a comfortable retirement.

At Safe Wealth Plan, our Safe Wealth agents are always available to discuss your annuity questions and help you create a retirement plan that suits your needs. Contact us today to see if an annuity is right for you.

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