Dispelling myths about annuities can open the door to many unique investment solutions.
Annuities can play a valuable role in providing guarantees1 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.
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.
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, with an industry average of 1.04%.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.
Learn more: Fidelity's low-cost FPRA
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 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: 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 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 maximize future income, DIAs provide the greatest advantage if you don’t need to access the money until you reach your selected income start date.
Another consideration with deferred income annuities is the ability to invest incrementally over time by making additional payments. Similar to dollar-cost averaging, building your income plan in increments allows you to stagger your investments with a range of interest rates and possibly take advantage of higher future interest rates. To learn more, read Create future retirement income.
Another alternative is a deferred annuity with a GLWB, which allows some flexibility with your investment but typically offers a lower income stream. When you purchase this type of annuity, you will lock in predictable, guaranteed lifetime income that begins when you are ready to start receiving income. 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.7
Deferred annuities with GLWBs come in two varieties, fixed and variable. They both allow you to have access to your account value,8 but the fixed type offers a guaranteed rate of return on your account value with no market participation. The variable type allows you to invest in one or more mutual funds, allowing market participation.
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, or, if you select a joint contract, both lives. 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 a single premium immediate annuity (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. 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.
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.