What Are the Downsides of Annuities?
With how generally low-risk annuities are, one would think they’d be a relatively non-controversial choice among financial professionals. And while a number of advisers are more generous towards annuities citing that they’re more customizable and flexible than detractors give them credit for, there is still a vocal group against them.
Two of the big downsides of annuities are high fees and a lack of liquidity with your money. As we previously mentioned, annuities can be customized in a number of ways through riders, and the final result can be a much more robust investment product. They can even be set up like life insurance where, should you happen to pass before you’ve recouped the entirety of your initial investment, the money is passed down to benefactors, for example. Broker fees and service fees are high for this level of customization, however.
In fact, when the Department of Labor was looking to pass a fiduciary rule in 2016 that pretty much said brokers needed to act in their clients’ best interests, sales of annuities dipped substantially. Then, when the rule was overridden in 2019, sales of annuities surged. The reason brokers favor annuities is that they can make upwards of 10% in commission off the principal, which can mean a $10,000 payday on a $100,000 annuity sale, with fees increasing the more the annuity is amended and customized.
In short, because there’s an incentive for brokers to sell annuities and complicate them to increase commission, annuities have earned a reputation as predatory. If you’re interested in buying an annuity, it’s essential to shop around to various insurance companies and brokers in order to guarantee you find someone trustworthy who is acting in your best interest.
Similarly, there can be a lack of flexibility and liquidity with annuities which, when broken, can incur high fees. When you put a lump sum into an annuity, essentially you’re surrendering it to the terms of your contract. If you’ve invested $100,000 in a deferred annuity that isn’t set to pay out for 10 years, but after five you determine that you need $50,000 back for an emergency, that withdrawal can incur a penalty. Some annuities have a grace amount built in. For example, you may be able to withdraw $10,000 without a fee, but the additional $40,000 may see a penalty of 5% or more.
One final sticking point with annuities is that they’re primarily bought through insurance companies, which are not backed by the federal government in the same way that banks are. Because there is no FDIC insurance behind an annuity purchase, if the insurance company from which you purchased the plan happens to fold, you risk losing everything you invested. If you do plan to buy an annuity, make sure that the insurance company supplying it has a credit rating above an A quality. If you’re handing over a large sum of money, it better be to someone you can trust.