Purchasing an annuity can provide long-term financial stability for you, especially during your retirement years. However, setting up an annuity contract isn’t always the most lucrative way to manage your savings.
You can lose money on your contract if you surrender your annuity or withdraw funds from it early, but you also can lose money if your annuity funds aren’t invested advantageously. There are steps you can take to protect yourself from losing money on your annuity.
Are annuities a good investment?
How can you lose money in an annuity?
Most people buy an annuity with a large sum of money to set up a regular income stream during their retirement years. Annuities are designed to help manage your money, but they don’t typically allow for much flexibility.
If you need to deviate from the terms laid out in your contract, you’ll likely face financial penalties that could result in a reduction of your annuity’s accumulated value.
Learn more about how annuities work
Surrender charges
Annuity contracts usually have a surrender period during which you have to pay a surrender fee if you make an early withdrawal. Surrender periods typically last seven years, but the length can vary.
During the surrender period, the earlier you make a withdrawal, the higher the surrender fee you have to pay. For example, you may have to pay a 5% surrender fee for taking out money from your annuity in the second or third year, but only a 2% fee if you withdraw money in the fourth or fifth year of your annuity.
After the surrender period is over, you won’t be obligated to pay surrender fees if you need to make an early withdrawal. But you could still be subject to other penalties and fees.
Do annuities affect financial aid and other benefits?
Early withdrawal penalties
Depending on the details of your annuity contract, you could be responsible for paying withdrawal penalties. In addition to any surrender charges, if you withdraw from your annuity before you reach age 59 ½, you’ll have to pay a 10% tax penalty on the money you withdraw. [1]
Can you withdraw money from your annuity?
Insurer’s weak financial ratings
In the unlikely event that the insurance company that provides your annuity is unable to honor your contract, you’d risk losing all the money in your contract. When you’re shopping for an annuity, make sure you feel confident in the company’s ratings before you make an official purchase.
An insurance company’s financial rating indicates its financial strength and ability to fulfill its contractual obligations to policyholders.
The federal government doesn’t insure annuities so it’s important to check an annuity company’s financial ratings before you buy an annuity from them. [2]
What is the impact of interest rate changes on your annuity?
What are the risks of losing money depending on the type of annuity?
One of the main distinctions between different types of annuities is how the money from your annuity is invested. Fixed, indexed, and variable annuities are all invested differently, which leads to different levels of potential growth and risk.
While you can lose money directly through fees and penalties, you can also lose money indirectly by forfeiting growth. Depending on the type of annuity you buy, you could give up the opportunity for more money. Knowing the different types of annuities and how they work can protect you from missing out on potential growth.
Fixed annuities
Fixed annuities are guaranteed to grow at a constant but low rate. Because the insurance company guarantees a certain growth rate in your contract, they assume the risk if there’s a market downturn.
If you’re risk-averse, a fixed annuity is a good option. However, the rate of growth you receive may not be enough to keep up with inflation. If this happens, you’ll actually lose money by using a fixed annuity compared to other investment options.
Indexed annuities
Indexed annuities generally offer you more earning potential than fixed annuities because growth is tied to a stock market index. The growth of your money will correlate to the stock’s performance.
Indexed annuities typically come with both floors and caps. Floors guarantee a minimum rate of growth for you, but caps limit the amount of growth you’ll receive. This means if the stock tied to your indexed annuity performs exceptionally well, you’ll miss out on those gains if they exceed your cap.
Variable annuities
Variable annuities are the riskiest annuities you can get, but they also offer the greatest potential for growth. With a variable annuity, you’ll invest your money in stocks, bonds, or market indexes directly through subaccounts.
The payments you’ll receive from your annuity will fluctuate based on how your selected investments perform. However, unlike indexed annuities, there are no caps or floors with variable annuities. This means that if your chosen investments perform poorly, your annuity can lose money.
Learn more about fixed annuities vs. variable annuities
Life only annuities
Life only annuities guarantee that you’ll receive payments for the rest of your life — no matter how long you live. “The biggest selling point of a life only annuity is the fact you can never outlive it,” says Brian Ford, senior sales associate at Policygenius.
If you live for a long time, this can be very advantageous, and your annuity could actually end up paying you more than what you paid to purchase it. However, if you die sooner after buying it, you could lose most of the money you used to purchase the annuity. One way to protect against this is to get a life with period certain annuity instead, which allows you to leave money to your loved ones if you die earlier than expected.
Learn more about life only vs. period certain annuities
How can you avoid losing money in an annuity?
While annuities can be complex, they are generally safe financial products that can help you prepare well financially for retirement. And if you purchase an annuity, there are steps you can take to protect yourself from losing money with your annuity.
Diversify your investment or retirement portfolio
Annuities function best in conjunction with other financial tools, such as an individual retirement account (IRA), pensions, or 401(k) plans. Diversifying your finances is one of the best ways you can protect yourself financially. This way, if one of your accounts underperforms, you’ll still be able to rely on the growth of the others.
“Annuities can be great tools, but it’s important to know they’re not perfect,” says Nicholas Bunio, certified financial planner at Retirement Wealth Advisors. “Nothing is. And not all your money should be in an annuity, much like not all your money should be in cash, stocks, etc.”
Can annuities be used as collateral for a loan?
Choose the right type of annuity for your profile
There are many different types of annuities to choose from. Deviating from your contract’s terms can be financially costly, so it’s important that you set up an annuity where you’re confident it’ll meet your long-term needs.
While there are many ways to customize your annuity, two of the main distinctions are:
How soon you’ll receive payments
How your annuity will grow.
Knowing how quickly you want your annuity to pay you, and how risk-averse you are will help you set up the annuity that’s best for you.
You can choose between an immediate annuity and a deferred annuity. With an immediate annuity, you’ll start receiving payments right away. With a deferred annuity, you’ll wait at least one year, but usually several years before you start receiving payments.
You can choose between fixed, indexed, and variable annuities, each of which has different risk and growth potential.
Learn more about immediate vs. deferred annuities
Choose an insurer with a strong financial record
You want to be confident that your annuity’s provider will be able to honor the terms of your contract. Before you buy an annuity, confirm that you feel secure in the company’s financial strength ratings. You can verify a provider’s financial strength with different ratings companies, such as Standard & Poor’s, A.M. Best, Moody’s, and Fitch.
Seek professional advice when shopping for annuities
Annuities are complicated, highly customizable financial tools. For most people, it’s in your best interest to work with a professional financial advisor who can assess your financial needs and help you make the best decision about what type of annuity to get, and explain any special features on your policy.
