Annuities, like any other investment product or opportunity, are not one size fits all. In many instances, you’ll need a well rounded financial plan to make it through to retirement, that is of course, if you don’t make a million dollars per year. Here are two common mistakes investors make when purchasing an annuity, and how to avoid slipping up.
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Starting Annuity Investing Too Soon
This happens too frequently with investors who are more interested in actually getting their hands dirty in their retirement planning to think about starting with a plan. Too many investors just jump in with both feet, without considering all possible routes and avenues your retirement portfolio may take on the long road to retirement. You may have as many as 40 years before you retire…and things can surely change in that time.
Although some company’s annuity rates might be tempting, be careful to note the annuities surrender charge before signing the papers. Surrender charges are nearly industry standard, and in many cases they’ll cost you as much as 10% if you need to make a withdrawal before your investment has aged for at least 10 years. A lot can happen in ten years, and frankly, you don’t want to pay a hefty sum just to get access to your money.
Also, regardless of how long you’ve owned the annuity, the IRS will want its fair share if you make a withdrawal before turning 59 and ½ years old. This penalty is 10% too, and when compounded with the surrender charge from the institution backing the annuity it can add up to a lot of money.
How to prevent it: Plan for an emergency fund of 3-6 months of income before investing in anything. Whether it be your own business or your retirement.
Don’t Be A Scared Investor
Far too many eventual retirees look at what they have to lose over what they have to gain. While annuities may be safe, their historic returns do not allow for the same kind of capital appreciation as that of a stock mutual fund or exchange-traded funds. However, on the plus side, they do offer security, security that you may end up paying extra for should the markets continue going up while your annuity produces returns equal to that of a bond portfolio.
Consider buying an annuity later in your retirement plan than sooner. Since you have plenty of time to correct investment mistakes made in your early career years, use that to your advantage and “splurge” on a little extra risk. The annuity portion of your retirement plan should never be greater than the amount that you would invest in other “fixed income” investments like bonds, CDs, or money markets. So if you’re a 20-something with 80% of your retirement plan going into annuities, well, you might be playing it a little too safe. Too much safety is just as dangerous as too much risk.