Annuities are insurance policies that help you save money for retirement. These products are often used in pension plans and by individuals who want to combine elements of insurance with savings. But annuities can have a dark side. Before you invest in one, you must consider the potentially adverse effects.
All contributions to annuities are non-deductible. You cannot use an annuity in the same way as an IRA. Because the annuity is non-deductible, you won't have as much money to invest as you would with a 401(k) or IRA.
Treatment Of Withdrawals
All annuity investment gains are taxed when withdrawn. Investment gains are withdrawn first from the contract. This tax treatment is known as "first in-last out." All gains are taxed at ordinary income tax rates. This decreases the amount you get in retirement, especially combined with the fact that you paid taxes on the contributions and thus had less to start with.
Some annuities charge significant fees, which also cuts into your retirement kitty. This is true of variable annuities, which might charge a policy maintenance fee as well as mutual fund fees. Other annuities, like indexed annuities, cap investment earnings or charge fees to limit growth in the policy in exchange for guaranteeing the annuity's account value once investment gains have been credited to the annuity. While the guarantees are nice, the growth limit is a negative.
Annuitization is the process of converting the savings to monthly payments. Once this happens, it is normally irreversible. This is problematic if you need a lump sum later. You won't be able to get it from the insurance company. You may be able to sell your annuity payments to a third-party settlement company, but these settlement companies generally give a lesser percentage of your savings.