Should I buy an annuity?

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Q. I have $600,000 in retirement accounts and a friend suggested I buy an annuity so I can create a “paycheck for life.” I know annuities can be expensive. What do I need to know?
— Learning

A. There are several different categories of annuities, so it depends on your needs and the type of annuity you are considering.

An annuity is basically a lump sum of cash invested to produce a monthly stream of income for a fixed period or for life, said Chip Wieczorek, a certified financial planner and investment adviser with Tradition Capital Management in Summit.

“Fixed annuities feature fixed payouts, and the income they generate is very predictable,” he said. “Variable annuities will tie the annuity’s payout to the performance of an index or some other basket of securities.”

Funds are not protected or insured by the issuers, but your state insurance association may provide some guaranty, he said.

Wieczorek said the positive of buying an annuity is that it can generate valuable income in retirement, and if you opt for a lifetime annuity, you’ll keep receiving those payments for the rest of your life.

“Some annuities will even raise your payouts to keep up with inflation, which can help retires maintain buying power over decades,” he said.

For some, annuity income can be preferable to income generated through an investment portfolio that has to be monitored on a regular basis.

Wieczorek said as you age, you’ll likely be less able or willing to manage your investments on your own. Annuity income takes the investment management hassle out of the equation and just keeps paying you.

The negatives of buying an annuity, in most cases, seem to outweigh the positive.

“First, annuities tend to lock up your money for several years,” Wieczorek said. “It’s not uncommon to pay a `surrender’ fee of 7 percent or more if you take your money out too soon.”

Also, he said, many annuities are sold by brokers who collect large commissions for doing so, some as high as 10 percent.

“If you don’t see a commission fee broken down for you, that doesn’t mean it’s free. It’s most likely added into the annuity’s operating costs,” Wieczorek said. “High annual fees are another negative of purchasing an annuity. It’s not unusual to pay between 2 and 3 percent per year.”

He said this is in contrast to other options such as managed investments accounts, which often charge around 1 to 1.5 percent per year, or directly buying exchange-traded funds that charge 0.50 percent or less.

“Make sure you do your homework on the annuity if you decide to buy one,” he said. “Just remember nothing is `free’ when it comes to investing. You can avoid commission charges by buying your annuities through companies that sell them directly or by using a fee-only adviser to guide you through the process.”

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NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.