Annuities are an investment vehicle sold by insurance companies to provide a fixed income throughout retirement. Annuities provide tax-deferred earnings and the option to turn principal in the annuity into a lifelong source of income. While annuities are a common investment, they are not without their drawbacks. An investor should be well aware of the pros and cons of annuities before placing her money into one.
No FDIC Insurance
Even if you purchase an annuity from an insurance company through a bank, you do not get the Federal Deposit Insurance Corporation's (FDIC) insurance guarantee--in other words, you are betting your money squarely on the financial stability of the insurance company, according to Bankrate.com. However, if that company fails, you may still be able to recoup up to $100,000 from your state's guarantee association. Each state makes its own rules, so it is important to check and see what kind of protection you will get before purchasing an annuity.
Safeguard Against Inflation
You can customize annuities so that they keep pace with inflation and the cost of living. This preserves the cash value of your annuity--an important protection--because inflation can kill upward movement made through investments. However, inflation protection often comes at an additional cost, which varies by company.
Tax-Deferred Contributions
Income earned that is placed in an annuity is tax-deferred, meaning you do not have to pay any income tax on those funds. Instead, you pay for the interest earned and withdrawn from the account.
High Cost
Annuities have a lot of costs to the insurer that drive up costs for the purchaser. Agents are paid a 5 to 10 percent commission upon the sale of an annuity. There are also maintenance expenses and a profit margin that has to be maintained for annuities to remain financially beneficial to insurance companies. How much this costs the investor can vary from company to company, but some annuity packages can be so costly that they nullify any tax advantages associated with the investment. This can lower the overall profit of your annuity, states NewRetirement.com.
Less Restrictive Than IRAs
Many IRAs have set investment limits that investors cannot exceed. A Roth IRA also limits itself to individuals within certain tax brackets. But, annuities have no limits on income or contributions--you can pay as much as you want into an annuity, whenever you want, and it does not matter how much or how little you make.
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