Annuities are available in all shapes and sizes. I don’t sell these products or earn any commissions from them, so I do tend to be wary about what the motives are backing many of these types of sales, especially when it comes to variable annuities, which are quite lucrative:

Complex variable annuities get oversold to people who don’t fully understand. This type of annuity is very hard to comprehend and incredibly complex.

Variable annuity salespersons earn very high commissions on these products; they are very motivated to try to sell them to you. A salesperson working on commission is looking out for their own interests and not yours.

You should only purchase annuities if the benefits are very compelling and complement your overall financial picture. Annuity salespeople tend to focus on closing the deal rather than considering the client’s overall financial situation and where the annuity might fit into that.

Annuities are not a good choice for everyone. If you are on Social Security, then you have an indexed, fix annuity already that is going to keep paying you for the rest of your life. The same thing is true if you have a pension. That is fixed annuity that also pays for life. The insurance element in an annuity, if nothing else, means that you will lose if you don’t live as long as some of your friends since your monthly payments will be redirected to other annuity owners who live longer than you.

So when it comes to annuities, what is the good, bad and the ugly?

The following is the smell test I use for Annuities:

The Good

If you earn a high income and are in a high tax bracket, then it might make sense to invest in a low-cost variable annuity if you have already maxed your IRA and 401(k) deferrals completely and are expecting that when you retire you will be in a lower tax bracket. The charge on a low-cost variable annuity is less than 1% annually.

A low-cost variable or fixed annuity might make sense if you are wanting to take a lump sum of money and convert into an income stream and you are able to afford for the money to be tied up for an extended amount of time (potentially forever).

If might be wise to invest in “longevity annuities” if you are worried that you will outlive your assets and you have the ability to lock some of your assets up in an annuity. You can set up a longevity annuity to start an income stream late in life. For example, Jane is 72, is in good health and longevity runs in your family. She places a maximum of 15% of her total investments in a deferred fixed annuity. Jane will start receiving monthly income payments from her $150,000 investment as soon as she turns 80 years old; those payments continue until her death. If she dies prior to receiving any payments, then the principle might be returned to her without any interest, but if she dies after she starts receiving her income stream she might have to forfeit the whole annuity.

There are new initiatives from the government to allow 401(k) investors to place part of their accounts into annuities. The government is worried about poor returns on 401(k) investments due to the fact that investors don’t always make wise investments. Providing annuities as an option is viewed as a way of providing more certainty and predictability for retirees.

A charitable annuity can be a great way to make tax-deductible donations to charities and get part of the donation as an income stream for life.

The Bad And Ugly

You can be stuck with a 3-4% annual fee on a variable annuity along with serious surrender penalties (up to 15 years or even longer).

If you are considering variable annuities that come with lots of bells and whistles but you really don’t understand them (does it seem to god to be true?), then I recommend that you get a second opinion from somebody who doesn’t benefit from the annuity sale.

Are you in a moderate or low tax bracket? Purchasing an annuity using after-tax dollars (in order to defer investment income) might be disappointing to you if you end up with a high-income tax bracket after you retire due to significant RMD distributions from your 401(k) or IRA, or due to overall tax rates being likely to increase in the future.

Also, if you use after-tax money to buy an annuity, it might end up being a poor tax decision. You will be trading lower tax rates on capital gains on taxable income for higher tax rates on ordinary income on your annuity gains.

It isn’t necessary to have an annuity as part of your IRA if you are wanting to defer income because an IRA is tax-deferred already. When an annuity is held in an IRA it is mostly redundant unless you are specifically wanting the mortality/insurance benefit.

A fixed annuity might augment you overall investment/financial strategy. However, currently, interest rates are very low. You would be much better off purchasing a fixed annuity where the higher interest rates are locked in where there are higher interest rates.


Your money might end up being tied up for the rest of your life. You cannot undo an after-tax annuity. Once your money gets put into an annuity structure, it has to stay in an annuity structure. There is the option to roll an ugly or bad annuity into an annuity that is less expensive if you don’t have surrender penalties any longer. However, the annuity structure itself cannot be terminated.

Do you plan on leaving your variable annuity to your heirs? Annuities that are invested in equities do not make a good inheritance since there isn’t any step-up in basis on the position’s death value on the date when the annuitant (initial owner) dies.

In summary, for some people, fixed annuities might be attractive when interest rates increase.

In my opinion, there are more cons to variable annuities than pros and you should only buy them after doing your due diligence and receiving an unbiased second opinion.

Retirement Planning and Annuities
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