Annuities often get bad press for the same reason other income strategies sometimes do: the financial media and many financial advisors have a vested interest in keeping you tied to growth-based financial strategies, even after you should have shifted your focus to investing for income.
Many of the advisors who badmouth annuities simply don’t have the knowledge to manage or even offer most of the tools in an income portfolio, including annuities. That’s why there’s a lot of misinformation about annuities, even though they’re versatile and can be an effective part of your retirement income strategy.
As you may know, an annuity is a financial contract between you and an insurance company. A fixed annuity is designed to generate income based on a minimum interest rate for the life of the contract. Market changes may force the insurance company to raise or lower its rate, but that wouldn’t affect your income return.
Annuities are also categorized by risk and how they generate earnings. That’s why you have fixed annuities in the conservative category and indexed annuities in the moderate box. Indexed annuities pay interest based on the performance of a specific market index, such as the S&P 500. While this gives them more growth potential, it also makes them riskier.
Variable annuities are what some people consider to be a great way to maintain all the risk of the stock market in the single most expensive way possible. Variable annuities typically lack liquidity, meaning they can tie up your money for long periods of time. If an emergency comes up and you need to access your money, you will be hit with surrender penalties.
There are rare occasions when a variable annuity might make sense, such as a doctor who wants to protect his or her assets from malpractice suits or creditors. These situations, however, are very few and far between.
The bottom line is that certain types of annuities can be effective in helping you achieve your income goals in retirement. With that said, you must be very careful to select the right type of annuity so you can help avoid costly mistakes.