Common Annuity Myths, Debunked

The short version: Annuities attract confident opinions from people who like them and people who do not. Most of the strong claims on both sides are describing one type of contract as though it were all of them. Here is what stands up and what does not.

Why the noise is so loud

Two things make this subject unusually prone to overstatement.

The first is that the word annuity covers several quite different products. A fixed contract and a variable one behave so differently that a statement can be entirely true of one and entirely false of the other. Both camps then argue past each other, each accurately describing a different thing.

The second is that annuities are sold, often on commission, and some of that selling has historically been poor. That has produced a well earned scepticism which sometimes hardens into a blanket rejection.

The useful position is neither. It is to know which specific claim applies to which specific contract.

"The insurance company keeps your money when you die"

This is the most emotionally charged claim, and it comes from a real feature applied too broadly.

A straight life income option does end at death. That is how it produces the largest payment: the insurer's obligation ends with you, and the pooling that funds the guarantee depends on exactly that.

But it is one option among several. A period certain continues payments to a beneficiary for a stated number of years. A joint and survivor option continues for a spouse's lifetime. A deferred contract that has not been annuitized simply passes its value to the named beneficiary.

The accurate version is that some payment options end at death and you choose whether to select one. We cover the choices in how annuities create guaranteed lifetime income.

"Annuities are always expensive"

This is true of some contracts and not of others.

Many fixed annuities carry no separate annual fee. The insurer's costs are expressed in the rate it offers rather than deducted visibly. That makes them straightforward to compare, because the credited rate is the credited rate.

Variable annuities are a different matter. They commonly carry an insurance charge, the internal costs of the investment subaccounts, and the cost of any riders. Those layers add up and they appear in different documents.

The reasonable response is not to avoid the category. It is to ask for the total annual cost as a single figure in writing, which we go through in annuity fees and surrender periods explained.

"Your money is locked up forever"

Overstated in both directions, depending on who is talking.

Deferred contracts have a surrender period during which withdrawals above a free allowance trigger a charge. That period ends. Most contracts allow some withdrawal each year without penalty throughout.

Annuitized contracts are different, and there the loss of access is real and generally permanent. That is a genuine consideration and it deserves to be stated plainly rather than softened.

The practical rule that resolves the whole argument: only commit money you are confident you will not need during the term, and keep a genuine liquid reserve elsewhere.

"Annuities are a bad investment"

This one is a category error rather than a falsehood.

A fixed annuity is not competing with the stock market and was never designed to. It is a contract that removes uncertainty from a portion of your money. Judging it by whether it beat an index is like judging an umbrella by how fast it goes.

If your goal is maximum long term growth and you have decades and a real tolerance for volatility, a fixed annuity is not the right tool and nobody honest would say otherwise. If your goal is that a portion of your money behaves predictably, it may be exactly right.

"Annuities are safe, like a bank account"

This claim comes from the other direction and it also needs correcting.

An annuity is not FDIC insured. It is backed by the issuing insurer's financial strength and, secondarily, by state guaranty associations with specific limits. That is meaningful protection and it is a different system from the one covering a certificate of deposit.

Anyone describing an annuity as equivalent to an insured bank deposit is either confused or being careless with your money. The detail is in insurer strength and guaranty associations.

"You should never put an annuity inside an IRA"

Half right, and the half that is right is worth knowing.

If the reason given is tax deferral, the objection is correct. An IRA is already tax deferred, so the annuity adds nothing on that front. Anyone selling on that basis is not describing the product accurately.

But people place annuities inside retirement accounts for other reasons, principally the income guarantee or a fixed rate on part of their retirement money. Those reasons stand on their own.

What we actually think

We work with insured and guaranteed accounts because our clients are mostly retirees whose priority is keeping what they have. Fixed annuities are one tool in that set, alongside CDs, savings and money market accounts.

They are not right for everyone and we say so regularly. The households they suit usually have a specific gap to close and other money kept liquid. The households they do not suit usually need flexibility more than certainty, or are being pointed at a contract far larger than the job requires.

If you would like an unhurried, unpressured view on whether one fits your situation, schedule a free consultation. We are equally happy to tell you it does not.

This article is for general education and is not financial, tax, or legal advice. Please speak with a licensed professional about your situation.