Common Mistakes People Make When They Consider Annuities

"Annuities can be useful tools for pre-retirees and retirees who seek a steady stream of guaranteed income when they no longer work. However, there are pitfalls of which potential annuity buyers must be aware."- Ed Hochard

If you are pre-retiree or already retired, you may know that annuities can be excellent sources of extra income to bolster your Social Security, pension, or other retirement accounts. Many financial experts believe that nearly all retirees benefit from having a portion of their retirement funds in annuities. However, anyone purchasing an annuity needs to have a rudimentary grasp of how this product works and what it does to protect your wealth. It's unfortunate, but many seniors don't take the time to perform the necessary research before purchasing safe money products.

Here are some of the most common mistakes you should avoid when deciding to add an annuity to your retirement matrix.

The failure to clarify why you think you need an annuity in the first place.

Although annuities are gaining increasing favor among financial planners, not everyone needs one. If you don't need or want the protection of your principal investment, income for life, a shield against the risk of living too long, or the creation of a legacy, you probably don't need an annuity.

Consider your appetite for risk and your desire to ensure your money lasts as long as you do when you look into this product.

Choosing the wrong provider or product.

All annuities and annuity companies are not equal. For example, people chasing market returns may select variable annuities. Variables are significantly different than fixed indexed annuities. For instance, most variable products don't have the guaranteed rates of return of other types of annuities. Instead, the variable annuity's performance correlates to the growth of its' underlying investments.

There is typically much more risk with a variable than with a fixed product. Adding risk by choosing a variable annuity could be an issue since you probably want to eliminate risk from your portfolio as much as possible. Also, since annuity guarantees derive from a company's ability to pay claims, there is a definite need to research and scrutinize annuity companies before spending any money to ensure they have financial stability.

Not understanding associated fees.

Several kinds of fees are inherent in annuity products. You should know about these charges so that you'll understand them when comparing products and consulting an advisor. For example, there is a mortality and expense risk charge that pays the insurer for the risk assumed in the contract. This fee is generally around 1.25 percent annually or a percentage of your account's value.

Some annuities also have administrative charges for other features you've selected, such as the guaranteed income benefit or long-term care rider.

Investing too much money into an annuity.

Understandably, most people tend to become risk-averse as they transition into retirement. After all, most of us can't afford to lose money when we are no longer working. Fear of outliving your savings may cause you to want to stuff as much cash as possible into an annuity. Putting too much money into an annuity is seldom a viable strategy, though. It would be best if you understood that, even though annuities can give you excellent safety and peace of mind, you will also have less liquidity, control, and flexibility with these products. If you are hit with a life emergency and forced to draw out more than a certain percentage from your annuity, you might risk losing your income guarantees or be on the hook for additional charges.

The wise course of action is to meet with your financial planner to calculate precisely how much of your savings needs to be in annuities by adding up your anticipated expenses and subtracting pensions, Social Security, and other guaranteed income sources.

The bottom line:

Annuities are solid, proven products offering a degree of safety and predictability for those nearing retirement. However, like any financial tool, they come with their own set of pros and cons.

Adding an annuity to help you achieve your overall financial objectives may be an excellent idea. Still, you need to partner with your advisor to ensure you've looked at every angle. After all, once you've retired, it will be almost impossible for you to recover from any bad decisions you've made with your finances.