What are the pros and cons of annuities versus stocks?
I’m 62 years old and trying to manage what I have in my stocks, and I've been looking into annuities. This product sounds great because of fixed funds, but I don't know much about them. What are the pros and cons of annuities versus stocks?
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Annuities provide a fixed income until you die, which is very attractive for retirees. Investing in stocks offer much greater potential for growth and often provide greater income in retirement, but stocks also come with them greater risk of losses and more effort to manage.
The pros of an Annuity
With a fixed annuity, the fact the insurance company is taking on the investment risk is a big plus, and an annuity might be a good choice for a portion of your retirement funds to provide you with your basic living expenses. Realize though, that Social Security provides the same benefit, so an annuity may not be necessary to provide for your basic living needs. If you are highly risk averse, annuitizing a small portion of your portfolio to supplement Social Security for basic living expenses (like food and medicine) could be a good idea.
And now for the cons
Annuities have very low rates of return built into them, and over long time periods generally will pay out less retirement income compared to a balanced portfolio of stocks and bonds.
Annuities also have very high costs built into them, further reducing the payout relative to the potential payout of a well-managed portfolio of stocks and bonds.
When you purchase an annuity, you give your money over to an insurance company, meaning they own your money. You won't be able to get the money back and you'll be stuck with the set annual income. This can pose a problem if you have an emergency such as your house needing a new roof or a major medical expense.
Once you buy and start an annuity, there is no going back. Unlike your stock portfolio, you can't change annuity companies or pull your money out of the annuity.
There is no ending balance with an annuity, so there won't be any money left for your children and grandchildren to inherit. A period certain annuity would provide some inheritance if you died young, but it would lessen the amount of income the annuity pays you.
Most annuities aren't adjusted for inflation, so what seems like plenty of money at the beginning of your retirement will likely leave you in financial hardship toward your later retirement years. There are inflation adjusted annuities but you'll see a significant reduction in the monthly income they pay you (as much as a third or greater reduction).
Insurance companies can and do go out of business, and if the insurance company you chose goes out of business your annuity income will likely be greatly reduced or be eliminated altogether.
Annuity sales practices can be very predatory, and a bad annuity advisor (sales rep) can easily lead you to believe something which isn't true. Annuity sales practices have often been identified by regulators as problematic and anti-consumer. And these annuity sales practices are one of the main reasons the Department of Labor attempted to implement their fiduciary rule.
I Generally Don't Recommend Annuities for Typical Clients
As you are making this decision, you will likely talk with a 'financial advisor' who sells annuities to explore and subsequently purchase the annuity. Realize these advisors are really commissioned product sales reps and you will likely be getting advice with a high level of conflict of interest. You potentially will get a very well-rehearsed sales pitch disguised as advice, and you may not be presented with the downsides of the investment nor the alternatives.
If you are exploring an annuity, make sure to get a second opinion from a fee-only and fiduciary financial advisor before you make this decision. We do this analysis for free because of the prevalence of bad annuity sales practices. Fiduciary advisors have a legal obligation to serve their client's best interests (most advisors don't) and the fee-only part means they don't earn extra money from kickbacks or commissions if you follow their advice.