The 7 Drawbacks to Fixed Annuity Products

4. Limited Access to Cash

Fixed annuity products are not checking accounts. They do, however, allow the consumer to withdraw money from the contract in many ways but with restrictions. The three most common ways contracts allow access to cash are 1) by a partial withdrawal from the contract, 2) a full surrender of the contract and 3) by taking payments based on one of the contract’s options or riders. If the consumer takes more than a certain percentage of the contract’s value (usually 10%), they will be subject to a surrender charge. Most annuities come with a surrender charge schedule that requires the buyer to pay a fee if they surrender the annuity contract in a certain number of years (i.e., typically 6 to 10 years) from purchase. These fees can be significant. So, it is hard to back out of a contract once purchased. Overall, consumers should only put money into an annuity contract that is being invested or saved for the medium to long-term.

5. Additional Taxes for Withdrawals Prior to Age 59½

If withdrawals are taken from a fixed annuity contract prior to age 59½, in most cases, an additional 10% penalty or tax will be due on withdrawn interest earned. Remember, annuities were intended to create supplemental retirement income and withdrawals prior to age 59½ trigger this penalty. There are some exceptions to this rule and consumers should consult their tax professional to get the specifics.

6. No Additional Tax Benefit for Qualified Funds

If a buyer funds their fixed annuity purchase with pre-tax or qualified funds, they do not receive any additional tax deferral benefit for doing so. Qualified funds are already tax deferred by law and, thus, get no additional income tax benefit by being placed into a fixed annuity. Many consumers buy annuities using qualified money, however, to obtain the basic benefits that annuities offer that other savings products do not, such as guaranteed lifetime income.

7. Complexity

One of the cardinal rules of saving and investing is not to buy a product you don’t understand. Annuities are no exception. Consumers need to be sure they understand the contract they are purchasing and its key features, benefits, costs and restrictions.

Fixed annuity contracts can be extremely valuable for the consumers who need them. They can provide guaranteed fixed rates of return, potential returns tied to investment market indices, protection of principal and guaranteed lifetime income in exchange for certain drawbacks or restrictions. They are a financial tool that can be used to create tax-advantaged returns and supplemental lifetime income. The key is for buyers to understand the drawbacks and to make sure the annuity products they buy fit their needs and risk tolerance.

Harry N. Stout has been the president of Fidelity & Guaranty Life, deputy chief executive of Old Mutual Financial Network, and managing director of Insurance Insight Group. He is also the author of The FinancialVerse personal finance books and of a new book, Today’s Annuities — A Tool to Create Protected Lifetime Income.

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