Pros and cons of annuities: An annuity is a terrible investment

The ~~pros~~ and cons of annuities

What is an annuity? A terrible investment!

Why? Unnecessarily putting your money in prison, lacks liquidity, has early withdrawal penalties, MUCH more taxes than you were led to believe, risk of insolvency, higher administrative costs, conflict of interest, limited investment choices, etc, etc

Here's what over-zealous investment advisors will conveniently NEVER tell you about annuities because they just want to earn that HUGE sales commission (of typically 5 - 14%) which comes indirectly at your expense. Most investors do not even understand the complexities of how annuities work, but they get fed plenty of "happy talk" from crafty annuity salesmen. Usually annuity pushers will subtly try to hurry up and get you to sign the papers before you have a chance to read websites like this one. Well here's some cold hard facts for you to consider first....

For starters you want to avoid being "trapped" in investments that penalize you for early withdrawal with "surrender fees", yet you are just that with annuities until age 59 1/2. Even if you wait until age 59 1/2, your entire investment INCLUDING your original investment principal will be taxed if is in a "pre-tax account". Young people especially should NEVER invest in annuities because if a "rainy day" ever comes along and you need to withdraw money, you will be CRUSHED with DOUBLE TAXATION! Statistically 25% of annuity holders withdraw money early and they pay dearly! This figure may have risen since the 2008 stock market crash. Certainly even more people probably WANT to withdraw money early but don't because of the massive penalties. If you're even as old as 39, in your right mind do you really want to put your money behind bars for 20 years?? NO WAY!!

In 2003 a study examined the effects of taxation on annuities relative to other investment vehicles. The study found that annuities are generally NOT effective as a tax-deferral investment after all! So why trap yourself in an investment until age 59 1/2??? Instead just invest in some broad market index fund ETF's, which outperform the average managed mutual fund, and ETF's don't have the many other unacceptable deal breakers described below.

If you ever need to cash out of a portion of an annuity before age 59 1/2, just for starters you are hit with mandatory Federal (10%) AND state tax penalties (1% in California) that are NOT tax deductable in any way, meaning you cannot deduct against it with losses (such as stock losses, property taxes, etc). PLUS that same amount that you withdraw is ALSO treated as taxable income that is essentially TAXED A SECOND TIME!!! How much EXTRA you are taxed depends on your tax bracket, plus how much your state will bilk you for. So, for example in California, when it's all said and done, after you are taxed twice you're REALLY looking at a total of 27% in Federal and state early withdrawal penalties if you earned $40,000 that year. If you're in an even higher tax bracket then that withdrawal will be taxed at an even HIGHER rate! This often comes as a BIG surprise to investors because the investment advisor (or rather "salesman" or "shark") that sold them the policy and the life insurance company that issued the annuity policy ONLY stress the 10% mandatory Federal tax. They CONVENIENTLY omit telling you about the ADDITIONAL federal and state taxes that blind side you the second time, or they bury it in the fine print. It's all part of how they soften the shock when trying to sell you the investment so that they can lock in the lucrative deal.

So annuities are advertised as being this "great tax advantage", when in reality annuities are taxed at HIGHER RATES than stocks or mutual funds!!! Whenever you start withdrawing money from an annuity, the gains are heavily taxed as "ordinary income" RATHER than at the lower and more reasonable "capital gains" tax rate. If your money was in a "pre-tax account" then the original principal that you invested is ALSO taxed. This contrasts with stocks, bonds and ETF's in which the principal investment is NEVER taxed -- Only gains are taxed.

Later life insurance companies will tell you "it's not our responsibility to warn you of this" and "it's your responsibility to discuss this with your accountant" and they'll tell you that this information is already disclosed (or rather BURIED) in the prospectus fine print, which of course nobody reads or understands.

THERE'S MISINFORMATION EVERYWHERE

Easily more than half of the web sites I found about annuities shamelessly have either NO mention of the fact that money distributed prior to age 59 1/2 is ALSO added to your adjusted gross income (and TAXED AGAIN and taxed MIGHTILY as "ordinary income") or it's presented vaguely or sort of buried in the small print.

Here's an investment advisory company that ONLY mentions the 10% IRS penalty, completely omitting any mention of the additional "ordinary" state and federal taxes that you pay.

Here's an annuity salesman who ONLY mentions the 10% IRS penalty (at 1:52).

AND you typically must ALSO pay an additional 6% penalty to the company that sells you the annuity if you cash out in the first year. Each subsequent year (for 6 more years) the life insurance company penalty drops by 1%. So if you were to cash out of an annuity in the first year you might get hit with perhaps a grand total of 33% in penalties and taxes on an early withdrawal if your adjusted gross income (including the annuity withdrawal) was $40,000 for the year.

Annuities have annual administrative costs that typically total (on average) 8 tenths of one percent MORE than mutual funds as well as annual "mortality and expense" charges. This is how they recoup that hefty 5 - 14% commission that they paid out to the sales rep who duped you into investing in the annuity in the first place! Remember that YOU indirectly PAY for than hefty sales commission that your broker earned when he talked you into buying the annuity! And you thought that you were getting a bargain when there was no "front end load" fee to pay as is common with some mutual funds. It's all about the slight of hand. You were duped.

If you want to make a quick reallocation of funds within an annuity in the middle of the day (such as if investor panic causes the market starts to free fall) forget about it! With annuities any reallocation order you place will not take place until the END of the trading day.

And when you look at the familiar names of the top 30 stock holdings that they pick, you will ask what on earth am I paying these bloated annual costs for??? Any novice investor can pick Apple, Microsoft, Home Depot, Oracle, Boeing, Johnson & Johnson, Bank of America, etc. Annuity managers invest in stable, large cap, household name bellwether companies. There's no rocket science here. You could have just invested in a broad market ETF instead.

Annuities are "advertised" as being safe, when in fact Executive Life Insurance Company became insolvent in 1991, leaving investors royally screwed. Since then at least 62 other major insolvencies have occurred!!! An annuity is only as safe as the insurance company that backs it. Furthermore, with the US government in such debt, some are saying that life insurance companies are at high risk because they are typically over-exposed to none other than long term government bonds. The risk of insolvency ALONE is enough reason to never invest in annuities. The consumer advocate group Weiss Research is actually currently advising investors to GET OUT of annuities because of government debt concerns.

Annuities usually have very limited investment choices. Usually the various funds that you get to choose from are simply warmed over variations of the same large cap stock funds, government bond funds, and a cash fund -- NO corporate bond funds, NO gold funds, and NO high dividend paying stock funds. In late 2011 Sun America suddenly decided to eliminate its "cash management" fund from at least one of its annuity groups, thus FORCING investors to stay invested in riskier securities.

Over-zealous, commission hungry annuity pushers are always going to want to get you to invest as much as possible in an annuity. To help you feel more comfortable about investing in an annuity they may tell you that states have laws that require that insurance agents determine if an annuity is "suitable" for a client by taking into account such rudimentary factors as life expectancy, money available to pay bills, risk tolerance, tax implications, and overall retirement goals. Unfortunately these "suitability requirements" are nothing less than a joke. Just for starters why would anyone subject their savings to mandatory ordinary income taxation? After reading this page you will agree that NO annuity is "suitable" for ANYONE!

As rule #2 states, never invest more than 5% of your savings into any one investment! So if you are heavily invested in an annuity (or annuities that were all issued by the SAME company) then that entire investment hangs on the stability of that ONE insurance company that wrote the annuity contracts!!! Unfortunately all too often financial planning consultants break this most incredibly basic rule because they're only concerned with pocketing that HUGE sales commission. They don't care about you. If you are also paying your broker an annual maintenance fee then they are picking your pocket TWICE if they are selling you annuities. As rule #1 states, don't act on investment advice from anyone who is ALSO trying to sell you the investment, especially annuity pushers who broker the deal.

CONCLUSION: Investing in an annuity is like putting your money behind bars until you turn 59 1/2. Don't put your money in prison! STOP being played by your self-serving investment advisor / broker! Avoid anyone who tries to convince you to invest in an annuity, or for that matter any investment that has a "surrender fee" or "early withdrawal penalty". They are in business for themselves. If your broker didn't tell you the annuity cons described on this page then give them a tongue lashing. If they are ALSO charging you an annual fee only to recommend long-term investments like annuities then I'd fire them! If you are only in your 20's or 30's and they are pitching annuities then slam the door when you leave! And finally run for the hills from anyone who suggests that you invest a huge chuck of your nest eggs in an annuity! If you need stability and/or steady income then invest in securities such as high dividend paying stocks, preferred stocks and trusted name blue chip stocks, or much better yet just buy and hold an unmanaged broad market index fund ETF. Studies have shown that broad market indexes have outperformed professionally managed mutual funds over time. And you can sell that ETF any time you want for only about ten bucks a trade, with NO early withdrawal penalties or "surrender fees", and you pay only the sensible "capital gains" tax rate.

As reported in BusinessWeek: According to the NASD, investors who bought into annuities made at least 7,000 complaints about variable annuities in 2003.