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The Truth About Annuities

6 Annuities FAQs:

Yesterday we talked about how useful annuities are for retirement planning. Today we are going to look at some common misconceptions about annuities.

Fact or Fiction? —

1)  Many different investments offer a guaranteed income stream. — Fiction!

Annuities are the only financial planning option that can guarantee a continuous stream of income throughout the duration of one’s life other than pension plans and Social Security. Annuity FAQSince the average life span of most Americans has increased significantly throughout the last few decades, many retirees now face an increased possibility of outliving their savings. Sensibly, many individuals have included annuities into their portfolios as a means of foundational income to hedge against inflation as the years increase and to avoid principal erosion as taxes increase.

Annuities can provide added assurance that comfort and security will continue on long after retirees have left the workplace. Annuities also have the added benefit of providing retirees with a means to increase their current incomes.

2) Annuities are subject to a 10 percent IRS penalty for early withdrawals before the age of 59 ½. — Fact!

In exchange for tax deferral, fixed annuities like IRAs are subject the 10 percent IRS tax penalty levied against early withdrawal. In addition, annuities like CD’s are subject to issuer surrender fees upon early withdrawal. So if you are likely to need your funds prior to retirement age you should  opt for CDs, money-market, or securities-oriented investments in order to avoid the additional tax from deferred annuities.

3) Fixed annuities are risky investments that can lose principal. — Fiction!

During the accumulation phase, fixed annuities allow you to lock in a rate of return much like a Certificate of Deposit and the principal is guaranteed by the insurance company. Variable annuities on the other hand are based on an underlying portfolio of stocks, bonds and other investments and thus may lose value in a market decline. However, once an annuity enters the distribution phase the insurance company is required to meet the terms of its agreement regarding distribution.   Prior to 2007, individuals who held fixed annuities may have been a little concerned that they had played it too safe with their portfolios. Fixed annuities had held the unrepentant reputation of being modest in growth, secure, and unexciting.

Needless to say, after millions of people lost substantial principal during the 2008-2009 financial crisis, fixed annuity owners were satisfied they had made a wise choice securing their futures. The safety net surrounding the fixed annuity had proven invaluable to those who opted for this boring, yet dependable, “tried and true” retirement allocation.

4) Fixed annuities earn less than banks and never earn what stocks do over any considerable time span. — Fiction!

Both fixed annuities and CDs are often considered the prudent means in which to guarantee principal and assist in a secure financial future. Indeed, both of these options are good candidates for the risk-wary investor or for a foundational portion of a risk-oriented portfolio.

However, when compared, fixed annuities typically offer interests rates 1 to 3 percent higher than that of CDs. In fact, over the last decade, from 2001 to 2010, fixed annuities have actually outperformed many stock index market returns and could potentially continue to do so over the next decade.

5) Annuities have penalty-free withdrawals each year until the end of the contract. — Fact!

   Most annuities offer a penalty-free withdrawal of up to 10 percent annually of the principal and interest the annuity has gained. This reduces the risk in situations when liquid funds might be needed unexpectedly. Also, many annuities include waivers in the contract to remove surrender charges in case of serious illness or other such difficulties. This is not the case with other investment options such as mutual funds, CDs, or bonds.

Annuity surrender charges have been at times overstated by naysayers to discourage annuity allocations that can genuinely benefit in the long run when annuities are being used for the right reasons.

6) Surrender charges are draconian measures to punish clients and make insurance companies wealthier. — Fiction!

   Surrender charges are incorporated to discourage annuity holders from pulling money from their accounts for frivolous reasons that do not constitute an actual need or emergency. This helps ensure the full balance of the annuity will remain untouched and earning interest until the proper time, when a retiree needs the annuity to achieve his or her retirement goals and objectives.

Additionally, the avoidance of paying surrender charges by pulling money out early allows the insurance carrier to invest money safely for a longer period of time, thus enabling higher interest rates or returns for all of the annuity owners.

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