Annuities, as a whole, often get bad reviews. Money mavens and financial pundits, through various TV shows and business publications, love to reel off a list of criticisms about annuities’ suitability and relative value for consumers.
And for some people, sure, these criticisms may have some validity. Annuities aren’t the right choice for everyone. Situations are different from person to person, so what’s financially appropriate for one individual isn’t necessarily the right choice for someone else. That’s why particular circumstances and choices have to be studied and, in many cases, financial professionals consulted.
But that doesn’t mean annuities aren’t appropriate for anyone. In many cases, annuities may offer an answer to worries about longevity and outliving retirement income. Or satisfy a desire to diversify future retirement income streams. Indeed, some annuities are specifically designed to help accumulate savings for long-term goals while others focus on providing a guaranteed income stream that begins either immediately or in the future.
So, just as one product doesn’t fit all needs, blanket criticisms don’t necessarily apply to all cases. So, what are some of the more common criticisms aimed at annuities generally — and what makes them fair or unfair?
All annuities are bad
Annuities come in many varieties, designed to perform in different ways for different purposes. Yet there is a tendency to take a complaint about a particular type of annuity and its application to a certain situation, then apply it generally to annuities as a whole.
It’s a little like complaining that all cars are bad because a two-seater sports car can’t haul a load of bricks or a pickup can’t go from 0 to 60 mph in less than four seconds. Cars are useful; you just have to pick the right car for the purpose. It’s the same with annuities. They are useful; you just have to pick the right annuity for what you want help to accomplish. (Discover more: Annuities overview)
Annuities lag market investments
This criticism is a favorite from those with businesses and interests tied to market investments.
But it misses both a central feature of annuities — the guarantee of income in the future — and the recognition of market risk inherent in other investments.
Sure, an equity portfolio can have impressive gains. But it can also fall flat on its face, depending on the stocks in the portfolio and the overall market. And other types of investments — fixed income, real estate, commodities — are also subject to market risks. Performance of those investments isn’t guaranteed and can sometimes even be negative.
By comparison, many annuities may offer a lower rate of return, but without the risk that typically underlies investments with higher rates of return. You are giving up the chance for a higher return in exchange for the guarantee. (Related: How annuities work)
Now, some annuities tie fund growth and payouts to market investments, introducing some market risk. Whether that type of annuity is suitable will depend on the individual.
Annuities are expensive
This criticism usually goes hand in hand with the market-lag complaint above. And it’s one of those that typically applies to certain types of annuities, yet paints the entire category with the same brush.
The overall complaint misses the point that an annuity isn’t so much an investment as a tool. And the more complex the tool — picture a multispeed, cordless, self-leveling drill/driver versus a simple hand-crank drill — the more it’s likely to cost.
Some kinds of annuities have very little or even no fees involved. But other types of annuities have fees related their investment structure. Additionally, some annuities provide riders, allowing the addition of certain benefits or terms to the underlying contract, at an additional charge.
And, of course, the cost of an annuity will vary from provider to provider. And, just like tools, people are sometimes willing to pay a little more to purchase from a brand with a reputation of reliability and quality.
Annuities involve surrender charges
Withdrawing money early from some annuities will typically trigger a surrender charge. This charge can vary in size and structure, depending on the annuity contract terms.
Critics point to such charges as being an unnecessary burden should someone need to access to the annuity principal if an unexpected expense arises.
Of course, withdrawing money from a certificate of deposit or a retirement account can also draw a penalty.
Money needs time to earn a return. That’s the nature of investment. In the case of an annuity, an insurance company needs to be able to count on the funds being there for an investment return over a certain amount of time, because it is guaranteeing payments to the annuity owner at a later date.
This is one of those areas where, if someone may need access to the funds in the short-term, an annuity may not be the best option. Or perhaps that person should look for an annuity offering lenient surrender charge or partial withdrawal terms. (Discover more: Understanding surrender charges)
Annuities are sold on commission
Some folks argue that the commission system adds to the expense of a financial product like an annuity.
But all financial products have costs tied to their creation, marketing, and management. And those costs are recouped either through fees, commissions, or a combination of the two.
For many consumers, paying a one-time commission is more economical than paying ongoing costs for buying and retaining a product, financial or otherwise. The choice, of course, is up to the individual.
An annuity is only as good as the company behind it
With the exception of government securities, this criticism can be leveled at any financial investment or vehicle.
True, many industries, including insurance, have some regulatory backstops. But such fallbacks can be time consuming and fall short of consumer expectations.
That’s why it’s important to look at the history and track record of the company backing an annuity. You should also look at its financial strength. Various rating agencies review insurance companies on a regular basis. (Click here to see MassMutual’s latest ratings.)
In addition, some people consider the basic ownership structure of an insurance company. Some believe the differences between publicly traded companies owned by shareholders versus mutual companies controlled by policyowners can be important. (Discover more: Pros and cons of mutual vs. stock insurance companies)
In the end, most general criticisms of annuities miss the point that they come in different varieties with different purposes and, as a result, different prices. Some annuities are designed to help you accumulate savings for long-term goals like retirement. Other annuities focus on providing a guaranteed income stream that begins either immediately or in the future.
And, given the range of what annuities can help with, some organizations believe that annuities should get wider consideration in retirement planning. The Alliance for Lifetime Income is one such example. It is a nonprofit formed and supported by some of the nation’s leading financial services organizations, including MassMutual, to create awareness and educate Americans about the importance of guaranteed lifetime income.
Of course, what makes sense for an individual investor will depend on their goals and circumstances. Just remember, you wouldn’t want to pay for the financial equivalent of a sports car if you only plan on hauling bricks.
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This article was originally published in June 2019. It has been updated.