Ask yourself why. Have you studied your options? Have you done your own research? Are you sure they provide the return you would like for the risk you are willing to take? How have your different options performed over time?
Or instead, are you considering annuities because someone is selling you on them?
Consider what personal finance author and Forbes contributor Tim Maurer had to say on the subject: “In the realm of personal finance, no word has been dragged through the mud more times than the A-word—Annuities. Yet annuities survive and even thrive. How they do is not a mystery. There is not an outcry on the part of consumers demanding annuity products. The reason for the continued vibrancy of annuity sales is that they pay a big honkin’ commission to the selling broker or agent. As some wise person once said, ‘Annuities are not bought, they’re sold’”.
Advantages of Annuities
Maurer cites annuity advantages and disadvantages. First, three advantages:
All annuities offer tax-deferral. From the time you put money into an annuity product, any future taxable interest or gains are locked into the product and cause no annual taxable event.
Income stream. Immediate annuities offer actuarially created stream of income whose “rate of return” can rarely be outdone by any other conservative fixed income vehicle because it is returning both your principal and any gains. Some of the most attractive features of variable annuities often involve a similar form of annuitization.
Principal protection. Fixed annuities offerprincipal protection. They also tend to offer longer terms than CDs and may, at times, offer higher rates. Variable annuities also attempt to offer a form of principal protection. Your policy may have a death benefit attached—which means that if you invest $100,000 and lose $20,000, you’ll get your money back…after you die. Recognizing the inherent disadvantages of that benefit, many insurance companies now offer a “living benefit guarantee” that allows you to receive lost principal during your lifetime, for a price and typically over several-to-many years.
Disadvantages of Annuities
Maurer lists three annuity disadvantages;
Tax disadvantages. When you take distributions, there are two nasty surprises. First, every penny of gain inside of an annuity is taxed at ordinary income rates—your marginal tax rate, personally—even if the gains were in equity-driven “funds” or sub-accounts in a variable annuity. If you’re in the top tax bracket of 35%, that’s 20% higher than long-term capital gains rates. Second, annuities receive Last-In-First-Out (LIFO) treatment. So, if you invested $100,000 and it grew to $150,000, the first $50,000 you withdrawal will all be taxed—because the last thing “in” was your gains.
In exchange for the tax deferral, you’ll be waiting until age 59 ½ until you can take any gains out of the policy without paying a 10% penalty—similar to a Traditional IRA. Furthermore, annuities create a tax time bomb for your heirs as there is NO step-up in cost basis. So, the Apple stock you bought at the bottom will transfer to your heirs with a cost basis equivalent to the stock’s price on your date of death, while any gains in your annuities will require your heirs to pay taxes to get your inheritance.
Illiquidity. Big commissions for salespeople mean extended surrender charges for you. Although most examples aren’t nearly this egregious, I’ve seen Equity Indexed Annuities that pay a 15% commission to the selling agent but have a 20 year surrender charge for the investor!
Sales. Maurer cites this instruction from an actual annuities sales manual: The first step in the process is to get people to accept the idea of an indexed annuity without really knowing. The quality of the close is dependent upon the fact that the client doesn’t know where you are taking them until the very end.
Single Family Rentals – An Attractive Alternative
Even if you still think annuities are right for you, you should consider all your alternative options, including investing in single family rental properties.
Advantages of Real Estate Rental Investing
Cash flow. Rent creates an immediate income stream that is greater than income from annuities. It can both pay for management costs and additionally provide monthly revenue to the owner.
Return on investment. The combination of rental income and appreciation over time can create a dual income stream and a return on investment that is so attractive that some of America’s largest hedge funds re investing billions on single family rentals.
Leverage. Real estate assets provide the opportunity for you to finance your purchase with borrowed money in the form of a mortgage, or “soft money” investment, or hard money from a bank or commercial lender.
Tax benefits. Rental income is favorable as long-term capital gains are realized when you sell the property.
Liquidity. Rental properties are much more liquid than annuities. They can be sold quickly, in as little as two or three months in most markets. Demand is stronger for rentals than owner occupied homes.
Disadvantages of Real Estate Rental Investing
Risk. Risk is greater with single family rentals than annuities, but the rewards are also greater. Real estate values rise and fall over time. Management quality and cost can impact return. However, as an owner you can control both by investing in a strong real estate market, and by selecting a trusted manager like HomeUnion®, who will minimize cost and maximize your return.