How safe is an annuity?

When planning for retirement, there are various financial products you can choose to invest in. One of these financial products is an annuity, which provides retirees with a steady income in retirement. However, annuities are not created equal, and some annuities may be riskier or safer than others.

Annuities are a safe investment vehicle for retirees looking to create a guaranteed income in their retirement. Individuals can fund an annuity with a lump sum or regular payments in exchange for guaranteed income for a specified period or over their lifetime. However, annuities carry some level of risk depending on the type of annuity product.

Are annuities safe?

Annuities are one of the safest investment vehicles you can have in your retirement portfolio. Unlike stocks and bonds, annuities are not affected by market fluctuations, and your money is guaranteed to continue growing over time, regardless of how the stock market performs.

One of the features that makes annuities attractive to retirees is that they pay a guaranteed stream of income in retirement. If you exhaust your retirement savings or Social Security benefits, the annuity will continue making payments for as long as you are alive. Also, there are no limits on the amount you can invest in an annuity.

When purchasing an annuity, you can make a lump sum or regular contributions to the annuity. In exchange, the annuity provider will pay you a guaranteed income for a specified period or over your lifetime.

How do annuities rank by risk?

The potential risks that annuities are exposed to vary according to the type of annuity you have. Some annuities carry more risk than others. Here is how annuities rank by risk:

Fixed annuities

Fixed annuities carry the lowest level of risk. These annuities pay a guaranteed rate of return that remains constant regardless of market fluctuations. This means your money will continue growing at a fixed interest each year for the term of the annuity. However, fixed annuities provide less growth potential compared to variable annuities.

Fixed indexed annuities

Fixed-indexed annuities carry a moderate level of risk, higher than fixed annuities but lower than variable annuities. These annuities are tied to an underlying index market like the S&P 500, and the returns you get depend on the market performance. A fixed-indexed annuity has a guaranteed minimum rate of return to protect you from losses, and a guaranteed maximum rate of return to limit your earnings.

Variable annuities

Variable annuities carry the highest risk but they also provide the potential for big earnings. When you buy a variable annuity, the money goes into investments known as subaccounts, which may include stocks, bonds, and mutual funds.

When the subaccounts perform well, you can expect to earn a higher return. However, if they take a downturn, you will see a lower return or negative return. Variable annuities carry more risk than fixed annuities since they don’t guarantee any returns, and you will be susceptible to market fluctuations or a recession.

Can you lose money in an annuity?

You risk losing money in an annuity if you invest in a variable annuity. This annuity is invested in the investments such as stocks and mutual funds, the returns fluctuate based on market performance. If the market performs poorly, you could lose money. However, if you invest in a fixed-indexed annuity, there is a guaranteed minimum return that limits how much money you can lose.

Additionally, an annuity can lose money if the annuity provider goes bankrupt and defaults on the annuity. Since annuities are not FDIC-insured, you risk losing some of your account value. However, some states require insurance companies to belong to a state guaranty association, which pays claims when a member company goes bankrupt.

Does recession make annuities riskier?

A recession does not make annuities riskier, but it could exacerbate the risks already inherent in an annuity. During a recession, variable annuities bear the biggest risk since their performance is tied to the stock market.

If the underlying investments are impacted negatively by a recession, this impact will be reflected in the variable annuity's payouts. On the other hand, fixed annuities provide greater peace of mind during a recession, since they maintain a fixed interest rate even in a volatile market.

The biggest risk is likely to be triggered by the annuitant’s action than the economy. Annuitants may consider an early surrender to get access to the annuity funds, which could trigger surrender charges. Also, the annuitant risks losing the principal investment due to a loss of value.

How do annuities compare against other investments?

Annuities are one of the safest investments for retirees looking for a guaranteed income in retirement. They are safer and provide more benefits than other investments like retirement plans, stocks, bonds, etc.

Annuities can be structured to mimic other types of investments. For example, variable annuities are tied to the performance of the stock market, while fixed annuities work the same way as bonds. However, annuities provide less volatility, and they can be structured to provide an income for the rest of the annuitant’s life.

Annuities may also provide more benefits than employer-sponsored plans like 401(k) and 403(b). While both options allow contributions to be tax-deferred, annuities do not have a contribution limit; annuitants can contribute as much as they can to build more savings. Both 401(k) and 403(b) have an annual contribution limit that employees cannot exceed.

Pros of an annuity

Guaranteed income

An annuity provides a guaranteed stream of income over a predetermined period or for the rest of your life, depending on the distribution option you choose. This ensures that you will have a regular income, even if you exhaust your other sources of retirement income.

Tax-deferred growth

The contributions you make to an annuity are tax-deferred, meaning you won’t pay taxes on the contributions and earnings until you start receiving annuity payments.

No contribution limits

There is no limit on the amount you can contribute to an annuity, allowing you to save as much as you want within a short time. If you have maxed out your employer-sponsored retirement plan contributions, you can channel your contributions to an annuity.

Cons of an annuity

Dying early

Annuities are good investments for individuals who experience long retirements since they can receive payments for a long time. However, if you die early, you risk wasting a chunk of your savings. Unless the annuity has a death benefit provision, your beneficiaries may not get access to the remaining annuity value.

Lack of FDIC insurance

If the insurance company that provides your annuity goes bankrupt, you risk losing the money you put into the plan. Annuities are not FDIC-insured, and you may not have options to recover your money.

High fees

Annuity contracts have higher costs, including commissions, annual maintenance costs, and operational charges than other investments like mutual funds and bonds. Also, if you surrender the annuity early, you may be subject to surrender charges. Before signing the annuity paperwork, check the fees associated with the annuity you are buying.