What Are the Disadvantages of an Annuity? When Are They a Good Idea?

Annuities are popular tools for a reason: They’re the only financial product that offers guaranteed retirement income, and they can safely grow your retirement savings. They are fantastic products for many, but, like any financial product, they have trade-offs.

Annuities are intended to grow your money over the long term, so they’re usually not very liquid. Some annuities incur relatively high fees. Some are tied to investments, which can introduce market risks. And so on.

Whether an annuity is right for you depends entirely on your situation and needs.

In this article, you’ll learn about some of the disadvantages of annuities. If you’re on the fence about annuities, these are the factors to consider—and the ways to mitigate those risks.

Annuities Can Limit Your Liquidity

One limitation of annuities is illiquidity. 

Usually, you fund your annuities with a single lump sum payment (single premium annuities) or with several payments over time (flexible premium annuities).

Then, your money might grow in your account for several years (deferred annuities), or your annuity may begin to pay you back an income right away (immediate annuities).

In each case, annuities are designed to be long-term products. Once you put your money in, it can be difficult or costly to take it out.

With immediate annuities, once you start to receive your income, you typically can’t access your annuity funds. You usually have to wait until your money is paid back to you.

With deferred annuities, you typically can withdraw your money early but keep in mind:

• Some annuities might have withdrawal restrictions.
• If you withdraw during the surrender charge period, you may have to pay surrender charges.

• If you withdraw your money before you’re 59 ½, you may face tax penalties from the IRS.

There are some exceptions. For example, some annuity companies, including Canvas Annuity, offer annuity products that are built for more flexibility.

Some also let you access your annuity funds without penalties if you need them for healthcare reasons.

Still, it’s a good idea to fund your annuity with money that you are pretty sure you won’t need to access in the near future.

How can you mitigate this limitation? To reduce the issue of liquidity:

• Fund your annuity with money that you won’t need in the short term.
• Buy annuities that have flexible withdrawal policies.
• Choose types of annuities that are more flexible, like deferred annuities.

Some Annuities Have High Fees

Another disadvantage of some annuities is that they can be expensive.

This is situational—it depends on the annuity or life insurance company that you bought your annuity from. But be aware that some charge fees.

Some of the fees you may be charged include:

• Annual administration fee. These fees cover the cost of administering the annuity. They’re more common with variable annuities.
• Surrender charges. These are the fees you’d pay to withdraw money during the surrender period specified in your annuity contract.
• Investment expense ratios. These are fees associated with the cost of managing and administering investments. They’re usually only applicable to variable annuities.
• Mortality expenses (M&E). These are fees that insurance companies charge for death benefits. It’s usually only applicable to variable annuities.
• Agent commissions. Commissions are usually not an explicit fee, but rather they’re built into the crediting rate the insurer offers. Still, they can raise the cost of your annuity.

Remember that not all annuities come with high fees—it depends on the type of annuity you choose and the insurer who provides them.

How can you mitigate this limitation? To reduce annuity fees:

• Avoid types of annuities with higher fees (like variable annuities) and choose annuities with lower fees (like fixed annuities).
• Avoid withdrawing money from your annuity account during the surrender charge period.
• Choose an annuity company that doesn’t charge annual administrative fees (Canvas Annuity, for example, does not).

Some Annuity Types Come with Investment Risks

Some types of annuities are directly tied to investments. That opens them to stock market risk.

For example, variable annuities offer you an interest crediting rate that is tied to the investments you choose. If those investments do well, you get a higher interest crediting rate. On the other hand, if your investments do poorly, you could lose money.

Fixed-indexed annuities also come with investment risk. They offer an interest crediting rate that’s tied to a market index. Usually, fixed-indexed annuities are structured so that you can’t lose money. Still, you could earn 0% interest.

How can you mitigate this limitation? To reduce the investment risk tied to your annuity, choose fixed annuities. Fixed annuities offer you a guaranteed minimum interest rate. That means that your money will grow at the specified rate regardless of how the market performs.

Some Annuities are Complicated

One problem with annuities is that they can be complicated. They typically come with a long annuity contract that isn’t always easy to read or understand. Depending on the kind of annuity, there might be lots of terms and conditions explained in detail.

It’s a good thing that they’re written out in detail. It helps you understand exactly how your annuity is going to work and what to expect. But we know that it can be overwhelming to try to understand everything.

More than that, sales representatives aren’t always helpful. They can sometimes be confusing and use jargon that creates misunderstandings.

How can you mitigate this limitation? You can avoid feeling overwhelmed by buying an annuity from a company with straightforward annuity offerings and choices.

Canvas Annuity has designed simple annuities for real people, so you can feel confident you understand how your money is growing and how to turn your retirement savings into a guaranteed stream of income for the rest of your life.

Inflation Risks

Inflation happens when the cost of goods goes up over time. As the things we buy become more expensive, our money buys less. In other words, inflation erodes the purchasing power of money.

Inflation is a risk to annuities.

If the rate of return of your annuity isn’t higher than the inflation rate, the value of your money can decline over time. That risk isn’t limited to annuities. It applies to any investment option—mutual funds, CDs, stocks, or anything else.

How can you mitigate this limitation? You can’t predict when you’ll experience inflation, but you can hedge against it. One way to do that is by making investments that give solid returns on investment. That way, you’ll grow your money even while it’s losing purchasing power.

Another option is to buy riders that protect against inflation. For example, cost of living adjustment (COLA) riders adjust the annuity income you receive each year based on inflation indexes. In periods of inflation, your income would be adjusted to compensate.

How to Determine if an Annuity Is a Suitable Purchase for You

To determine if an annuity is a suitable purchase for you, carefully examine your financial situation, goals, and risk tolerance. That includes thinking about the limitations of annuities—and whether they matter for your circumstances.

What are Your Liquidity Needs?

Money that you put in an annuity might be difficult to take out. Consider whether you need your funds in the short term. If you do, you may not want to put that money in an annuity.

Typically, annuities are best for your retirement savings—money you’re stashing away for years in the future.

Do You Have an Emergency Fund?

It’s always a good idea to have a fund available to access in case of emergencies—your car breaking down, healthcare costs, and more.

It’s generally not advisable to put your emergency fund in an annuity because it can be difficult to access when you need it. Instead, consider shorter-term and more liquid investment options like cash, high-interest savings accounts, or CDs.

Annuities are much better for longer-term savings that you likely won’t need to access for many years.

Have You Researched Potential Annuity Fees?

Finally, research different annuity companies to avoid unnecessary fees and choose an annuity with the most competitive fee structure.

Annuities can be complex financial products, and the associated fees can vary widely between different companies and products.

By conducting thorough research, comparing products, understanding the fine print, and possibly working with a financial professional, you can find an annuity that fits your needs without paying excessive fees.

As always, ask a professional financial advisor if you need help.

Weigh the Pros and Cons of Annuities

Annuities can be powerful retirement products. Fixed annuities are especially well-suited for retirement: they grow your money at a guaranteed rate and then can be converted into a lifetime income.

But like any product, annuities have disadvantages—they’re not designed for everyone’s situation.

If you’re looking for a safe place to grow your money over the long term, they might be just the thing you’re looking for. But if you’re looking for a place to put your money for the short term, they might not be the right fit.

Want to learn more about whether annuities are right for you?

Feel free to reach out to our knowledgeable and licensed reps. They’ll be happy to help you find the information you’re looking for and tell you about the fixed annuity products we sell at Canvas.