Annuities are often presented as a risk-free way to participate in the stock market. Many annuity salesmen claim that annuity holders are able to capture the returns available in the stock market during up years, while being protected from losses in the down years. But while a variable annuity might sound ideal, it often comes with some hidden risks and disadvantages. Looking at the complaints of annuity customers is one way to avoid making the same mistake.
Many variable annuities are a better deal for the salesperson than they are for the investor. As Money Magazine points out in its Ultimate Guide to Retirement series, variable annuities are often loaded with charges and fees. One of the most significant charges is the up front commission, which can amount to 4 percent or more. So if you invest $100,000 in a variable annuity, $4,000 of that nest egg goes into the pocket of the person who sold you the product. In addition, there are often ongoing maintenance fees, which could amount to an additional 2 percent a year. Then there are the surrender charges, fees you will have to pay if you need to take your money out early.
Owners of variable annuities must pay taxes on the money they withdraw from their plans. If those annuity holders are under age 59 1/2, they will also be subject to an additional 10 percent penalty, on top of those ordinary income taxes. In addition, the long term capital gains built up in the various sub-accounts of the variable annuity are taxed, not at the lower capital gains rate, but at the taxpayer's ordinary income tax rate. As pointed out in the Ultimate Guide to Retirement in Money Magazine, this difference can mean a big tax bill for high income individuals.
While variable annuities are often presented as risk free, in reality they are subject to the same kinds of market risks faced by mutual fund and stock market investors. If the investments held within your variable annuity decline, you will end up with a lower payout. Paying attention to exactly how your annuity is invested can protect you somewhat, but variable annuities are still prone to significant market risk.