Not all annuities are created equal, and not all annuities provide the same level of principal protection – a misunderstanding that needs to be addressed. While it’s widely believed that annuities are a safer investment vehicle for retirement than most investments, the type of annuity you buy, the terms of the contract you sign, and the financial capability of the insurance company play a role in the level of risk associated with it. So, before we go further, you should consider that an annuity can cause you to lose money. Here are situations when you can lose money with annuities. 1. When markets fall. Immediate and deferred variable annuities don’t protect your principal or guarantee the amount you receive during the annuitization phase. Instead, because they invest their savings in stocks and bonds, they base their income on market performance. This means that investing in a variable annuity risks losing money compared to investing directly in a mutual fund. To protect yourself from losing money, you can add a contract rider that guarantees that you’ll receive a certain amount in withdrawals as income when you retire. 2. You may lose money with a fixed annuity if you die sooner. Fixed-income annuities guarantee that you will receive a specific amount of money for as long as you live or whether you’ve spent all of your money. Insurance companies merge everyone’s resources into a single account with estimates of how long annuity holders are likely to live to ensure they don’t lose money. The payments are calculated so that the principal will continue for the average life expectancy of each holder. Because some people live longer than others, people die, leaving their principal in the pooled account for the insurance company to keep. You can protect yourself by paying an extra charge to add a rider to your contract that guarantees payments to your beneficiaries if you die prematurely. 3. Fixed income annuities can lose money due to inflation. Fixed-income annuities have one disadvantage: you will receive the same amount of money for the remainder of your life or for the time specified in the annuity contract. While this may appear to be what you precisely need, keep in mind inflation. Having the same number of dollars now as you did ten, fifteen, or twenty years ago does not equate to the same value because inflation has devalued today’s money, affecting your buying power. You can prevent this by buying a cost-of-living adjustment rider. 4. You’ll pay surrender charges if you withdraw too early. When you invest in a deferred annuity, your money is contractually bound to the annuity for a set length of time. If you later want to access part of the whole amount before the surrender time ends, you’ll have to pay a specified surrender charge, a penalty price that can hurt your investment. These early-withdrawal costs can result in a significant financial loss. They are largest when you first deposit and gradually decline until they reach zero at the end of the surrender period. 5. Withdrawing before turning 59½ can cost you money in penalty fees. Because annuities are a tax-deferred investment, making withdrawals before reaching the official retirement age would result in a penalty from the IRS – typically 10% of the withdrawn amount. You can avoid this loss by waiting until you’re 59 ½ or withdrawing for medical expenses, college, child adoption expenses, buying your first home, and others, exempted from the 10% penalty. 6. You could lose your money if the insurance firm goes out of business. An annuity contract is an agreement between you and an insurance company. Like any other contractual agreement, it can be canceled by any of the involved parties if something goes wrong. Unfortunately, annuity holders are frequently among the last to get their money back if an insurance firm goes bankrupt. The insurance firm’s assets are utilized first to pay off its creditors. To reduce this risk, it’s essential to choose an insurance provider with a solid financial rating from organizations such as A.M. Best, Moodys, and Standard & Poors. Also, study the fine print to understand what would happen if the company goes bankrupt before signing any contract.
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