retirement

5 pros and cons of investing in annuities

Fees and expenses

The more complicated the annuity, the more expensive it's going to be. A straight fixed payout annuity with no riders will be less expensive than a variable annuity with any guarantee.

Longevity insurance -- a single-premium annuity purchased at age 65 with payouts beginning at age 80 or 85 -- may make the most sense, though it's not an inheritable asset. It's cheap compared with other annuities.

"If you have a variable annuity, there are mutual fund fees on top, commissions, monthly fee, annual contract fees. There are a lot of costs at the end of the day that average consumers have no idea that they are paying," says LaSpisa.

Restrictions and loss of liquidity

Annuities come with what is known as a surrender period.

After buying an annuity, that money is locked in for a certain period of time, typically from six to eight years, according to the Securities and Exchange Commission, or SEC. You can take the money out, but you pay a certain percentage in surrender charges for access to your money. That fee typically decreases by 1 percentage point each year until it ends. You may also pay penalties if you withdraw before age 59½, plus taxes.

After annuitizing the account, your money is basically gone. You've given the account to the insurance company in exchange for a regular income.

"The problem is that most people don't realize when they annuitize, they give up the account," says LaSpisa.

"When you lock in these strategies, you don't have an escape hatch," he says.

The guarantors

The income that annuities guarantee is backed up only by the insurance company, and to a certain extent, the state. Every state has a guarantee association that each insurance company doing business in that state has to pay into, which guarantees a certain level of protection for policyholders. In general, the amount protected varies from $150,000 to $300,000, depending on the state.

But there is no Federal Deposit Insurance Corp. to ride in and give you your money back if the company fails.

When you purchase an annuity, you become a creditor of the insurance company, so it's likely that you will get money that is owed to you for a couple of reasons.

"That book of annuity business was probably built on actuarially sound principles. The insurance company that is out of business would probably be able to sell that to somebody else, so you as a contract holder would not even see any disruption -- the checks would just start coming from somewhere else," says Craig Hemke, president and founder of Buyapension.com.

The risk to your money from an insurance company going under may be slight, but more cautious annuity investors may want to practice a diversification strategy.

"If you want to buy $1 million of annuities, you want to spread them around enough companies so that the guarantee is there," says Swedroe.

Further, you should buy only from highly rated companies.

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