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Advantages and Disadvantages of Annuity Investing

Advantages of Annuity Investing

An annuity provides more capabilities than any other type of investment available.

  • An annuity is a safe vehicle for investment and can be easily monitored
  • An annuity offers tax-deferred growth on earnings
  • An annuity provides resources that can last as long as needed; and
  • An annuity can offer a money-back guarantee.

Client Investment Protection

The fixed-rate annuity investment is unmatched by all investment standards. The annuitant cannot suffer a loss of principal, the interest rate is guaranteed, every dollar invested is guaranteed, there is no investment risk, and interest earned is guaranteed. The only time that the policy’s value can go down is if there’s a withdrawal. 

Insurance Company Financial Power

Due to the sheer volume of insurance companies, they collectively own, manage or control more assets than all of the oil companies in the world combined and more assets than all the banks in the world combined.

It was the insurance companies that came to the rescue of the banking industry during the Great Depression, not the federal government.

Insurance Company Reserves

By law, insurance companies are required to set aside reserves when a fixed-rate annuity is purchased. These reserves can be used for settling withdrawals and redeeming annuities, but cannot be used to pay any other unrelated annuity items (i.e., bad debts, overhead, claims). Since the insurance company’s annuity portion of business represents their smallest source of revenue, other profit centers money is used for this reserve fund.

The investor is protected by a legal reserve pool, which has mandatory membership for insurance companies in most states. The reserve pool’s purpose is to carry out the liabilities and obligations due to the investor, should the primary insurer go out of business.

Insurance Company Ratings

As with any business, insurance companies have independent ratings. Even though annuities may have a perfect record of accomplishment, the Insurer’s rating should also be taken into consideration. For a fixed rate annuity, investors prefer an “A” or “A+” rating. For variable annuities, since earnings are not dependent upon the Insurer’s solvency, the ratings are not so disconcerting. A.M. Best, the oldest rating company in the United States, rates companies in much the same manner as our public school system.

A+ Superior rating

A Excellent rating

A- Excellent rating also

B+ Very good

B Good

C+ Fairly good

C Fair

C- Fair

Other rating sources you should look at are Standard & Poor’s and Moody’s. In their review of the annuities market, Standard & Poor’s maintain the belief that the life insurance industry, which offers annuity products, remains the strongest in the financial services sector. This view is based upon the fact that the industry as a whole has a solid balance sheet.

Vital Performance

Though the interest rate guarantee depends on the annuity, fixed-rate annuities offer a specific and fully guaranteed rate of return for a specified period.

Professional Management

The professional management team plays a vital role in the annuity field. Each member is a specialist in his or her field. These specialists are licensed, regulated by the federal government, state insurance department, highly skilled, and trained to focus on a specific segment of the marketplace. As with overall ratings, independent sources track the performance of annuities. Specialized publications such as The Wall Street Journal can provide excellent articles on annuities and annuity performances.

Options for Withdrawal

Both fixed-rate and Fixed Indexed Annuities provide for withdrawal options; however, any withdrawal may be subject to a penalty or surrender charge. Most insurance companies permit annuity withdrawals of up to ten percent (usually based on the principal) per year without cost, penalty, or fees. When considering withdrawal options, consider that the restrictions applying to withdrawals will eventually disappear and that there is an estimated 75 percent of all people investing in annuities who never remove any money.

Guaranteed Death Benefit

Upon the death of the annuitant, the Fixed Indexed Annuity provides that the beneficiary will receive the greater of the principal plus any ongoing additions or the value of the account on the date of death. An older person desiring a high-income stream will find the Fixed Indexed Annuity guaranteed death benefit an ideal investment. It is based on the sum of all investments made by the owner or value on the date of death, whichever is greater.

The guaranteed death benefit will last until either:

  • The annuitant terminates the contract;
  • The annuitant annuitizes the investment;
  • The annuitant dies; or
  • The annuitant reaches a certain age, usually 75 or 80.

Decedent Probate

The value of an annuity will not be included when the gross estate is valued for probate purposes; therefore, all annuities avoid probate.

Disadvantages of Annuity Investing

What are the risks? The potential for long-term growth in an annuity is exceptional; however, as with any investment, caution and scrutiny should be utilized. The investment’s potential is dependent upon the market.

IRS Penalties

Although there are very few disadvantages to investing in annuities, and most of them will never affect the client, there are a few to take note of:

  • All annuities are subject to the IRS penalty, regardless of annuity type. Withdrawals made before the annuitant attaining the age of 59½ years are subject to a ten percent penalty. The exceptions to this rule are if the annuitant dies or becomes disabled, or takes a portion of the annuity’s assets paid out as income regularly (annuitization).
  • Monies accumulated are not tax-free; however, they can be deferred and can be indefinitely postponed. Taxes can be further deferred if:
  • The surviving spouse remarries, or the surviving spouse is named as the annuitant, and their new spouse is a beneficiary.
  • When both spouses die, the beneficiary would be able to postpone taxes for up to an additional five years.
  • The tax liability will be the value of the annuity at the time of death minus the amount invested, and then multiplied by the beneficiary’s tax bracket percentage. The contract owner is wise to withdraw money from the annuity when in the lowest tax bracket.

Insurance Company Penalties

Withdrawn funds of up to ten percent per year, after the first year, are not subject to penalty. The surrender charge applies only when amounts are withdrawn more than the free withdrawal privilege. The Insurer’s penalty schedule should be investigated before purchasing an annuity, as terms vary.

Surrender charges are not applicable if the annuitant dies or becomes disabled, or if withdrawals are limited to those allowed under the free withdrawal privilege, or systematic withdrawals of ten percent per year are made, or the penalty period has lapsed.

Rising Interest Rates

If an investor is “locked-in” to a fixed interest rate and the economy is experiencing a period of rising interest rates.


Inflation may be the biggest threat to long-term investments. While a stock market crash may cause some temporary losses in the stock investments, the market always fluctuates. If stocks are kept long enough, it is possible not only to regain the loss but also to make an eventual profit. Therefore, for the long-term, the investment must keep pace with inflation.

Surrender Charges

Deposits to the contract are not subject to a “load” or “front end fee.” However, withdrawals may be subject to a contingent deferred sales charge (CDSC) and are assessed on a sliding scale. Charges are based on either the date of deposit or the date of the contract.

Fees for other options are charges imposed for some additional provisions in the annuity contract, such as stepped-up death benefit, a guaranteed minimum income benefit, or long-term care insurance.

Annuitization/ AGE 59 ½

At age 59½, annuitization can be utilized, so that portions of the annuity’s assets are paid out as income regularly. Only a portion of the amount withdrawn is subject to taxation; however, when a lump sum is taken, the entire growth and interest become subject to income taxes.