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5 Annuity Myths and Misconceptions

byAnnuityRatesHQ Staff

Tue Feb 20 2024

Staff @ AnnuityratesHQ
5 Annuity Myths and Misconceptions

Simply put, annuities are insurance contracts. They are typically purchased through an insurance company but you can also buy them from financial planners, brokerage firms, or independent insurance agents.

By purchasing an annuity, you are entering into a contract with the insurance company. In this type of contract, you agree to pay into an account either with a lump sum or several payments. The monies in the account are then invested. Annuities are tax-deferred accounts. You put post-tax dollars into the account and it grows tax-free until withdrawal.

Once the account reaches maturity, you then annuitize the account to start receiving payments. Annuitizing converts the account into a series of payments. These payments usually are tied to the length of the recipient’s life, which is why annuities are commonly looked at as a retirement product.

Unfortunately, annuities have gotten a bad reputation by some in the financial planning realm. Misunderstandings about annuitization can lead to frustrations and negative consequences for account holders. Common misconceptions about annuities fuel this negative narrative. Let’s clear up some of these frequently spouted myths.

Myth #1: Annuities are Rigid

Annuity products are highly customizable to your individual needs and situation. During the process of choosing your annuity, you’ll make decisions about your return rate, payment structure, beneficiaries, and more. Once you’ve signed the contract, you are agreeing to the terms. Just like other contracts, if the terms of the agreement are breached, you may be charged fees and/or penalties.

Myth #2: Annuities Mean Cash is Tied-Up

While annuities don’t offer the same liquidity as other investments, their availability is highly dependent on the type of annuity you purchase. Because annuity products are all across the board, not all cash-out methods will be available for each type of account. Here are a few ways to get cash out of an annuity:

Direct Withdrawal

You can take out cash from most fixed, variable, and indexed annuities at any time before annuitization but you will incur surrender charges, taxes, and possible penalties.

Loans

You may take out a loan against the cash value of your annuity, using the account as collateral. Typically, this is only available if you have a fixed annuity.

Surrender

For fixed or variable annuities, you can surrender the annuity for its cash value. This is nullifying the annuity contract and will usually cost you in taxes and fees.

Crisis Waiver

If the owner of the annuity enters long-term care, becomes disabled, or is facing life-altering issues, a crisis waiver allows you to cash in the annuity without paying surrender charges. A waiver is similar to a rider and may be added on to a standard annuity contract for an additional fee.

Myth #3: Annuity Payments End When I Die

Single-life annuities do limit the payments to the owner's lifetime. If you die before the full premium has been paid out, the remaining balance is forfeited to the insurance company. However, there are ways to ensure any amount leftover in the annuity is passed on to your estate upon your death.

Period certain annuities are one way to ensure full payment of the premium. These are similar to a life annuity but rather than payments being tied to a lifetime, they are tied to a timeline. Payments are made for a set number of years and continue to be issued even if the owner is deceased. Period Certain annuities may issue smaller payments to account for the time period guarantee.

Joint or survivor annuities guarantee payments for the lifetimes of both the owner and another person. This person is usually a spouse. Choosing this option may also reduce payment amounts to account for the additional payment years.

Death benefit rider is a premium product that you can add to your annuity. This means the remaining balance will be inherited by a designated beneficiary. However, because annuities are tax-deferred accounts, this may leave your loved one with a tax burden.

Myth #4: Annuities Are Expensive

Based on the type of annuity product you buy, your purchase may come with fees. Typically the simpler the annuity the lower the fees. While complex annuities, with additional riders or premium options, charge higher fees. These fees usually fall into one of these categories:

Commission: An annuity is an insurance. The person who is selling the policy will get a cut of the profits. This is another reason to make sure your agent is properly licensed.

Underwriting: These fees go to those evaluating your policy, calculating the risks, and making sure the annuity is of fair value.

Fund management: There are management fees for maintaining your account and investment. Those fees are passed on to you.

Myth #5: Annuities Are a Scam

Most often when people feel scammed by an annuity, it’s because there is a misunderstanding about the costs, benefits, terms, or tax implications of the annuity. Ask targeted questions and confirm your insurance agent is properly licensed before signing any contract.

The benefits of annuities are:

  • No record-keeping requirements
  • Deferred taxes on account growth
  • No limits on how much you can invest
  • Consistent income during retirement years.

Annuities are often misunderstood. But deciding if they are the right product for you,  depends on your personal financial situation and long-term goals. Work with a trusted financial advisor to assure you are comfortable with all the terms and fees before adding an annuity to your portfolio.

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