Cons of Annunities

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By Kelcey Lehrich
eHow Contributing Writer

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Annuities are contracts issued by life insurance companies. These contracts can offer either fixed rates of interest or use variable-rate investments inside the contract. Annuities have many applications in personal financial planning and have a host of features and benefits. There are some important drawbacks to consider when purchasing an annuity. Be sure to look out for the pros and cons of any annuity recommended to you.

Lack of Liquidity

Annuities are contracts that have a surrender charge. A surrender charge is a penalty assessed by the issuer if the funds in the contract are accessed before the surrender charge is over. Many contracts have surrender periods of five years or more. Some are as long as 12 or 13 years. Both fixed and variable annuities can incur surrender charges. When considering an annuity, be sure to address your liquidity needs and understand the time commitment an annuity requires.

59 1/2 Rule

Regardless of the surrender period of an annuity, the funds in an annuity may not be accessed before age 59 1/2. Annuities are considered insurance contracts that accumulate dollars for retirement savings. As such, annuities are subject to the same 59 1/2 rule as individual retirement accounts, or IRAs, and 401ks. If the funds are accessed before age 59 1/2, the Internal Revenue Service will asses a 10 percent penalty.

Relatively High Fees

Variable annuities are notorious for charging relatively high fees. When comparing a variable annuity with other investment options, be sure to ask about all of the fees in the contract, including the mortality and expense charge, subaccount charges, 12b-1 fees, and living benefit rider charges. It is not uncommon for variable annuities to have charges that are two to three times greater than that of mutual funds or managed accounts. For one to chose an variable annuity over another investment vehicle, there should be a compelling reason, such as living benefit riders to justify the higher fees.

Industry Scrutiny

The annuity industry has been scrutinized for years by consumer-advocacy groups. Many annuities, especially equity-index annuities, are known for being pushed by financial advisers because they pay a high commission rate. It is often argued that fees paid to the adviser are never made up to the client in superior performance.

A Promise Is a Promise

When you purchase an annuity, you are buying a contract from an insurance company. A contract is only as good as the paper on which it is written. Be sure to investigate thoroughly the insurer with which you are doing business. Financial-strength ratings of insurers are available by services such as Fitch Ratings, Standard & Poor's and Moody's Investors Service.