Investing can be scary, especially in the short term. When you retire, it’s hard to watch the value of your lifetime of savings fluctuate as financial markets bounce up and down. Fear is a powerful sales tool.
Immediate annuities are an insurance product that prevents you from losing money and offers the benefit of guaranteed payments. However, there is a catch with those guarantees. Many annuities aren’t guaranteed to keep up with inflation, so the purchasing power of those guaranteed payments could decline over time. Tying up a significant portion of your money in an annuity also takes away some of your financial options and flexibility, because you can’t always get the money back out easily. And some annuities are outright expensive.
Here are some of the issues you could face if you invest your retirement savings in an immediate annuity.
Inflation risk. Inflation has been artificially low for years due to manipulation by central banks and the slow growth patterns of the economy. As a result, many people have forgotten how inflation can reduce the buying power of fixed income payments and guaranteed rates of return.
Inflation is a normal occurrence as the cost of goods and services increase over time. Back in the late 1970s and early 1980s, inflation hit double digits.
A diversified investment portfolio has the ability to grow and provide a return above inflation. However, if you purchase an annuity in today’s low interest rate environment, you could find yourself in a situation where your “guaranteed” rate of return is not keeping pace with the rising costs of goods.
It wasn’t too long ago that the average rate of return on savings accounts insured by the Federal Deposit Insurance Corporation exceeded 4 percent at your local bank. With the Federal Reserve planning to increase interest rates, the risk of inflation should be factored in to any annuity purchase.
Loss of flexibility. Putting a portion of your savings into an annuity means that it won’t be available for current expenses or emergencies. Here’s how you limit your options when you purchase a guaranteed rate of return from an insurance company:
- Penalties. If you change your mind or incur an emergency expense and want to pull your money out of an annuity, you’re probably going to face surrender charges. You could find yourself in the unfortunate situation of being subjected to surrender charges that exceed 10 percent. The insurance company is able to provide you with a guaranteed return due to the restrictive nature of the investment that makes it expensive if you want to withdraw your money early.