5 common annuity myths

Dispelling myths about annuities may reveal unique investment solutions.

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Key takeaways

  • Deferred annuities can help savers.
  • Many annuities are low cost.
  • Some annuities are designed to protect and lock in income starting at a future date.
  • Annuities are the only product that can guarantee a stream of income that you can't outlive.
  • Your beneficiaries may be able to receive payments after you die.

Dispelling myths about annuities can open the door to many unique investment solutions.

With recent market volatility still on our minds, annuities can play a valuable role in providing guarantees and strengthening an overall retirement plan. Despite a bad rap as being complex and expensive, annuities offer plenty of reasons to love these products—no matter what phase of life you are in—if you know what you need and you shop smartly. Some let your money grow tax-deferred before and during retirement. Others protect against market losses and outliving your savings. These guarantees1 come with a price, but for many investors the price is worth the peace of mind.

Here we debunk 5 of the most common myths and misconceptions around annuities, so you can make better decisions about your financial plan.

Myth 1: Annuities are only for retirees

Reality: Annuities can help savers too.

Generally, if you have maxed out on contributions to your employer-sponsored savings plan or IRA, deferred annuities can offer an additional tax-deferred vehicle to help you build wealth.2 With these annuities, you can grow your investment tax-deferred, then turn it into an income stream at some point in the future. You can choose from 2 types of deferred annuities:

Deferred variable annuities have investment options that are very similar to mutual funds. You can typically make unlimited3 contributions and control how you allocate among investment options. To benefit most from a deferred variable annuity’s tax-deferred savings opportunity, use a low-cost annuity—some products are available for fewer than 50 basis points (0.50%) of your investment annually.4

Deferred fixed annuities include single premium deferred annuities (SPDAs), which are similar to a certificate of deposit (CD). You are guaranteed an interest rate for a specific period of time, typically 3 to 10 years. These fixed annuities are backed by the issuing insurance company rather than by the FDIC.

"It's important with any annuity product to make sure you're investing with a highly rated company," says Tim Gannon, vice president at Fidelity Investments Life Insurance Company. "A good way to tell is by checking with a rating agency like Standard & Poor's or Moody's. These are independent rating agencies that conduct regular reviews of an insurer’s financial strength and ability to pay its contractual obligations."

For information on how annuities can help savers, read Viewpoints on Fidelity.com: How to invest tax-efficiently.

Myth 2: Annuities cost too much

Reality: Many annuities are low cost. Others offer potentially valuable additional features at higher costs, which you should consider only if you need to address a specific risk.

When it comes to choosing an annuity, first consider what you need the annuity to do: build savings or create income. Be sure to compare the cost against the value of each additional guarantee, feature, and benefit—and only pay for what you need.

If you need to maximize your tax-deferred savings, choose a low-cost deferred variable annuity. According to Morningstar Annuity Research Center, variable annuity annual fees range widely, generally from 0.10% to 2.10%, with an industry average of 1.10%.4,5 Of course, you will pay more if you need to address a specific risk with a guarantee, such as a guaranteed living benefit, which provides income or asset protection from down markets.

Generally, variable annuities charge explicit fees, while fixed annuities tend to offer an interest rate or income payout amount net of, or after subtracting, expenses. Focus on finding a competitive payout rate and an insurance company that is reputable and financially sound.

Myth 3: There is no point in buying an annuity for income before retirement

Reality: As you approach retirement, certain annuities can help protect your future income from market volatility, and some annuities can help protect against inflation.

If your retirement is 10 years away or less, you're probably worried that a drop in the market could erode the savings you've worked hard to accumulate. There are 2 types of annuities that stand out for their ability to grant you some peace of mind: a deferred income annuity6 (DIA), and a fixed deferred annuity with a guaranteed lifetime withdrawal benefit (GLWB) rider.

When you purchase a DIA, you select the future date on which your payments will begin, providing guaranteed income for the rest of your life no matter what the market does. Because they are designed to create future income, DIAs provide the greatest advantage if you don’t need to access the money until you reach your selected income start date.

You can lock in a cash flow that starts on the future date you selected when you purchased the annuity. At age 58, to create a $1,000 monthly lifetime income payment beginning at age 70, you would invest approximately $135,000 today. If you waited until you were age 70 to purchase an annuity, you would need to invest slightly more than $200,0007 for the same level of income.

These types of annuities also enable you to plan for inflation by offering a cost-of-living adjustment, known as a COLA. When you purchase the contract, for an additional cost, you can select to have your income increase annually by a percentage, typically 1%–3%. This COLA adjustment takes effect on each contract anniversary after you begin receiving income, but not during the deferral period.

Another alternative is a fixed deferred annuity with a GLWB, which allows some flexibility with your investment but may offer a lower guaranteed payment. When you purchase this type of annuity, you will lock in predictable, guaranteed lifetime income that begins on a date you select. Your lifetime withdrawal benefit amount will be tied to your age when you begin withdrawing and deferral period—generally, the longer you wait to take your lifetime withdrawal benefit amount, the higher it will be.8

Work closely with your financial consultant as you build a comprehensive retirement income plan to determine whether these annuities are appropriate for your personal situation.

Myth 4: I can easily create lifetime income from my retirement accounts

Reality: Besides Social Security and pensions, only annuities guarantee a stream of income that you can't outlive.

Because you can't predict the markets, you can't be sure that you won't outlive your investment portfolio. With an annuity, however, you enter into a contract with an insurance company that will pay you a certain amount for the rest of your life, giving you the peace of mind that comes from knowing that this specific income stream is guaranteed to never run out during your lifetime.

That’s because when you invest a lump sum with an insurer today, the insurance company guarantees you will receive a monthly income payment for the rest of your life. They can guarantee this income and even deliver it for less than alternative investment strategies because of mortality credits. Premiums paid by those who pass at an earlier age are leveraged to pay those who live very long lives.

"What people may not realize is, once you have your essential expenses covered by guaranteed lifetime income, you gain peace of mind and the freedom to pursue the things you love in life," observes Tom Ewanich, vice president and actuary at Fidelity Investments Life Insurance Company. "Additionally, you may invest your remaining assets for growth, rather than worrying about how to preserve and stretch your portfolio for the rest of your life." Just be aware that once you purchase an SPIA or a DIA, you generally lose access to these assets after the "free look" period—a brief period of time immediately after purchasing a contract when you can cancel the contract and have your money refunded.

For more on lifetime annuities, read Viewpoints on Fidelity.com: Create income that can last a lifetime.

Myth 5: The insurance company gets my money when I die

Reality: Your beneficiaries can receive payments after you die.

Most deferred annuities are designed to pass the account value on to your heirs. Income annuities offer options that can also provide for your beneficiaries in some situations. With income annuities, as long as you don't select the largest payout option of "life only," you can arrange to have income payments continue on to your beneficiaries if you were to pass away prematurely. Of course, this may decrease your income amount in comparison to a life-only contract but it could be worth the tradeoff, depending on your situation and desire to leave assets to a beneficiary. Be sure to work with your financial consultant and discuss the beneficiary options available to you for each type of annuity you're considering.

Bottom line

Annuities can offer flexibility both in how you save for and receive money in retirement. It all comes down to understanding that there are several different types of annuity products, each of which is designed to address a specific need or life stage. And remember, the best way to explore how they might complement your investment strategy is to work with your trusted financial consultant.

Next steps to consider

Make an appointment to talk with a Fidelity advisor.

Learn more about the types of annuities offered by Fidelity.

These annuities can offer growth, but it's important to know what you're buying.

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