Investors who desire stability in retirement may turn to annuities. However, this source of incomꩵe has a lot of less-than-ideal elements that people may 𓆏overlook.

Annuities 🐻may be the right choice for retirees who are averse to volatility and want to reduce longevity risk, but they can also be complex and hard to understand, leaving man📖y investors unaware of significant fees, certain rules, and possible risks.

Fees Can Be Costly

Annuities typically have various fees or commissions that eat into potential returns. These are a few of the fees𒉰 and charges to be aware of when reading the fine print.

Surrender charges

澳洲幸运5官方开奖结果体彩网:Deferred annuities are a type of annuity that only provides payouts after a certain period of time. These annuities may impose surrender charges if you withdraw funds before the payout period begins. This period is known as the 澳洲幸运5官方开奖结果体彩网:surrender period.

Surrender charges are typically represented as a percentage and are highest at the beginning of the annuity contract, gradually declining over time. After the surrender period ends, you typically won't be subject to a 澳洲幸运5官方开奖结果体彩网:surrender charge.

So, before you tie up your money in a deferred annuity, consider whether you'll need the money before the surrender period ends, as withdrawing the money early could result in hefty surrender charges.

Morality and Expense Fees

澳洲幸运5官方开奖结果体彩网:Morality and expense risk charges are meant to compensate insurance companies for the risk they assume in creating the annuity contract. These annual fees may range from about 0.25% to 1.75% of your account value and may be used to pay the commissions of the insurance salesperson you purchased the annuity from.

Administrative Fees

An insurance company will usually charge an administrative fee for the ongoing management and administration of the annuity contract. This fee could be charged annually at a flat rate or could be a percentage of the total account value.

Returns May Be Capped

Some annuities cap potential returns💮, limiting🦋 your upside.

For example, 澳洲幸运5官方开奖结果体彩网:indexed annuities are a type of annuity that's tied to an index, like the 澳洲幸运5官方开奖结果体彩网:S&P 500. They give retirees the opportunity to benefit from 澳洲幸运5官方开奖结果体彩网:bull markets and offer protection from losses during downturns. However, they also cap returns during market upswings.

Returns for annuities linked to equity indexes may be reduced by participation rates, caps, and other fees:

• Participation rates: When the insurance company credits a return to the annuity, only a percentage of the total return is credited. For example, if the participation rate is 80% and the index returns 10%, you would only get credited 8% (0.8*0.1).
• Interest caps: This puts a cap on the return that can be credited to your annuity. If the cap is 12% and the index gains 15%, you'd only receive up to 12%.
• Spread, margin, or asset fees: This fee is subtracted from the gain of an index. If the margin fee is 2% and the index returns 10%, the return credited to you would be 8%.

Insurer Risk

Depending on the type of ann🥀uity you purchase, it may be regulated by different state or federal government entities.

For example, fixed annuities and indexed annuities are regulated by state insurance commissions, while variable annuities fall under the purview of the 澳洲幸运5官方开奖结果体彩网:Seꦺcurities and Excha🌞nge Commission (SEC) and 澳洲幸运5官方开奖结果体彩网:Financial Industry Regulator♛y Authority (FINRA).

If an insurance company becomes insolvent, a state regulator may step in and use money from a state guaranty fund, a pool of money that's used to pay claims for annuity holders in the event of default.

Inflation Risk

All investments are subject to inflation risk, but annuities are especially vulnerable to this risk because they typically offer lower returns than high-growt♌h assets like stocks.𒈔

If the S&P 500 generates a 15% annual return and inflation is 5%, you'd still come out ahead with a roughly 10% real rate of return. Yet if an annuity yields a 6% annual return when inflation is 5%, the real rate of return would be less than 1%.

Additionally, fixed annuities, in particular, are subject to inflation risk because there's no guarantee that their returns will keep up with inflation. These types of annuities typically offer a fixed rate of return for a specified period of time and a guaranteed minimum interest rate.

Higher Tax Bills

Like distributions from 401(k)s and 澳洲幸运5官方开奖结果体彩网:traditional individual retirement accoun❀ts (IRAs), annuity returns are taxed like ordinary income. The way your annuity is taxed depe🍰nds on whether you purchased it within a retirement account or not.

If, for example, you purchase an annuity in a 401(k) or IRA, this is known as a 澳洲幸运5官方开奖结果体彩网:qualified annuity. With a qualified annuity, you essentially get the same tax benefits as you would when purchasing other investments in a 401(k) or traditional IRA.

Since 401(k) contributions are deducted directly from your paycheck, these contributions can reduce your taxable income. Additionally, you may be able to score a deduction on your traditional IRA contributions, depending on whether you have a workplace retirement plan and your income.

Your annuity can then grow tax-deferred over time. Once you decide to take distributions in retirement, that money will be taxed at 澳洲幸运5官方开奖结果体彩网:ordinary income rates. However, you won't have to pay taxes on Roth distributions, as you're required to pay taxes on your upfront contributions instead.

Lack of Step-Up in Cost Basis for Heirs

When you leave certain assets to your heirs—like real estate, stocks, and collectibles—these investments may be subject to what's known as a 澳洲幸运5官方开奖结果体彩网:step-up in cost basis. This means that when the original ow𒈔ner dies, the value of the assꦚet is adjusted to the fair market value at the time.

Let's take a look at an example: A person purchases a stock at $50, and it's worth $150 at the time of the person's death. The heir receives the stock with a step-up in basis. If the asset continues to appreciate in value and the heir sells it at $200, they owe 澳洲幸运5官方开奖结果体彩网:capital gains tax on the $50 gain ($200-$150).

However, nonqualified annuities aren't subject to a step-up cost basis, which means that when an heir receives an annuity, the cost basis is the same as it was for the original owner.

Here's what it would look like: A person buys an annuity for $50,000, and when they die, it's worth $80,000. Since annuities aren't subject to a step-up in cost basis, the heir would owe ordinary income tax on $30,000 if they cashed it out at $80,000 ($80,000-$50,000).

Early Withdrawal Penalties

Similar to other types of retirement accounts, like 澳洲幸运5官方开奖结果体彩网:Roth IRAs, receiving distributions before age 59½ can mean having to pay a 10% penalty. This penalty, however, only applies to the taxable portion that you take out. This typically means that your earnings will be taxed while your original contributions will not.

The Bottom Line

Annuities can provide retirees with predictable income and peace of mind, but that stability may come at a price if investors don't have a full understanding of the different rules, risks, and fees.

If you're weighing whether an annuity is right for you, make sure you understand the implications of cashing out early, the various fees, how they're taxed, and much more.