26 Jun I have $1 million. Should I buy an annuity?

Q. I have a retirement nest egg of nearly $1 million. I live off Social Security and I take distributions of about 4 percent a year, and that covers my bills. A friend said I should buy an annuity so I have guaranteed income. I hear annuities have high fees and I’m not sure what to look at. Where do I begin? I’m 69 years old and there is no mortgage on my house.
— Retired

A. You are correct most of the annuities have high fees. They’re complicated products that shouldn’t be purchased without significant research and understanding based on your goals and time horizon.

For starters, under no condition you should invest your entire nest egg of $1 million in annuity, said Dean Shah, a certified financial planner with Stonegate Wealth Management in Oakland.

“Depending on a specific situation, a small portion of total assets may be invested in annuities to meet a specific goal,” Shah said. “You will be better off investing in a well-managed diversified portfolio which matches your goals and risk tolerance.”

Your portfolio should be invested with both your long-term and short-term needs in mind, and it may be able to produce enough income so you don’t have a need for an annuity.

But here’s what you need to consider.

Shah said there’s a saying in the insurance world: “Annuities are sold, not bought.”

He said that means insurance sales agents sometimes aggressively sell annuities to clients that don’t need them.

Sometimes clients can benefit greatly from the right annuities bought for the right reasons, he said, but you need to understand the pros and cons before buying.

He said annuities are sold by insurance agents with promises to provide guaranteed income, provide good return without downside, and save on income tax, and more – but the guarantees are only as good as the insurance company.

“When you buy an annuity, you give your money to an insurance company, they invest the money and promises to pay you money later,” he said. “There is significant early surrender penalty.”

He said annuity salespeople get paid a very good commission and insurance companies like to make profits from your money. This is what makes annuities expensive.

More recently, non-commissioned annuities are sold by investment advisors. Investment advisors do not get commission but they may charge a fee, he said.

“The non-commissioned annuity might have better terms and no early surrender penalty,” he said.

There are several different types of annuities and they come with various riders, of course at an additional cost for each rider, he said.

Let us start with the most basic simple annuity known as the Single Premium Immediate Annuity (SPIA).

For example, you buy $100,000 SPIA annuity. You give $100,000 lump sum to the insurance company. In return insurance company promises you to provide you a monthly lifetime income,” Shah said. “The amount depends on your age and gender but not based on your health.”

For a 65-year-old New Jersey female, it could be almost $550 per month for life, he said. If you select a joint life option, your monthly income will be slightly less but will continue over yours and your spouse’s life.

“It is important to note that you will receive monthly income but you no longer have the lump sum money you gave to the insurance company,” he said. “The monthly income acts more like a pension. It provides a piece of mind that you will not outlive your savings.”

Insurance agents like to tout income tax advantage of annuities but are the advantages real?

Shah said there is no tax-deferred advantages If you buy annuity in qualified accounts or tax-deferred accounts such as an IRA because qualified accounts are already tax-deferred. When you buy an annuity in non-qualified or taxable account with after-tax funds, the growth is taxed as ordinary income upon withdrawal, he said.

Compare that to a properly tax-managed investment portfolio that would provide mainly long-term capital gains, which are taxed at a lower tax rate.

“So annuities trade a low tax rate for a deferred higher tax rate,” he said.

You should also become familiar with some of the more common types of annuities.

There’s the deferred income annuity, for which you could pay one or multiple premiums.

“Funds will gain by a fixed interest rate which could change,” Shah said. “Once annuitized, payments will be over a specified time or lifetime. The income stream is guaranteed, although growth in value depends on the length of time invested and interest rate.”

Then there’s a variable annuity, which could also have one or more premiums.

For this, funds are directly invested in mutual funds approved by insurance company.

“Later, you may withdraw the account value or you can annuitize, creating an income stream,” he said. “There are no guarantees unless a separate rider is bought.”

Or you might be offered a fixed income annuity, which also has one or more premiums.

“Unlike variable annuities, fixed income annuities do not invest directly in the stock market,” Shah said. “Instead, they link the performance of the annuity to an index, often the S&P 500 index. Later you can withdraw the funds or create an income stream.”

These are also usually sold with riders, he said.

So before you consider an annuity, make sure you understand how it works and what job it will have as part of your retirement plan. Consider talking to an advisor who is not an annuity salesperson to get an objective – and commission-free – view of the product.

Email your questions to .

This story was originally published on June 26, 2019.

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.