2783: Is an Annuity the Worst Investment a Young Person Can Make? by Jeff Rose of Good Financial Cents

[00:00:00] This is Optimal Finance Daily, Episode 2783. Is an Annuity the Worst Investment a Young Person Can Make by Jeff Rose of Good Financial Cents.com. And I'm your host and personal finance enthusiast, Diana Merriam. We're going to jump right into our post for today as we optimize your life.

[00:00:25] Is an Annuity the Worst Investment a Young Person Can Make by Jeff Rose of Good Financial Cents.com. Annuities are regarded as being best for older individuals near retirement who have accumulated respectable savings and can afford to diversify their portfolio.

[00:00:43] But can young people also benefit from an annuity? One of the best things that my mom ever did for me as a young adult was to start an investment strategy for me. She wanted to get me started with investing, so she set up an investment account with her

[00:00:58] financial advisor for my benefit. At the time, I was young, clueless, and completely indifferent. But when I began my career as a financial advisor, I finally became very interested in what investments I had. So I did some inquiring.

[00:01:14] Turns out, my mom's financial advisor was purely an insurance agent, and the investment I had was a fixed annuity paying 4.5%. I remember thinking to myself, why does a 24-year-old need a fixed annuity? Turns out, it was a very legitimate question. What is an annuity?

[00:01:37] Annuities are another form of retirement savings, just like IRAs, 401ks, stocks, bonds, mutual funds, and savings accounts. They're tax-deferred and come in a variety of types, with fixed, variable, and equity indexed being the most common. Fixed annuities act like a savings account.

[00:01:57] There's a certain amount deposited in the account, and that money earns interest. The interest is added to the value of the account and helps the account grow over time. Variable annuities act more like a mutual fund.

[00:02:11] The annuity holder selects the account they want to fund the annuity and puts a certain amount of money into each of those accounts. They make money based on how well those funds do. And equity indexed annuities act like a hybrid of fixed annuities and variable annuities.

[00:02:29] They offer downside protection by protecting your principal, but also limit your upside gains. Annuities are thought of as being best for people who have large amounts of money and who can afford to diversify their retirement portfolio. Typically, this describes older individuals who have accumulated some nice savings.

[00:02:50] But is that the only demographic that can benefit from an annuity? Young people and annuities. Whether a young person should purchase an annuity or not really depends on their financial situation and long-term goals.

[00:03:04] For young people who have short-term financial goals and not a lot of liquid assets, an annuity doesn't make any sense at all. Because of the penalties I'll describe, a young person would be better off with a regular savings account for short-term investing.

[00:03:19] However, if a young person is financially stable and looking to have diversity in their retirement accounts, the equity indexed annuity or variable annuity could be a viable option. Notice I say could be, not most definitely. A fixed annuity, on the other hand, doesn't make sense at all.

[00:03:39] Note, I would never choose an annuity over a Roth IRA or 401k. The tax-free benefit of the Roth and the pre-tax benefit and convenience of the 401k make both of these first stops.

[00:03:53] But if you already have these well-funded, an annuity can be a great place to stash more away for retirement. Annuity penalties. Read the fine print. There are some penalties involved for using funds from an annuity, either for early withdrawal or withdrawal before age 59 1⁄2.

[00:04:13] Most annuities have a surrender period ranging anywhere from 5 to 10 years. The penalty for withdrawing before the surrender period has passed varies with each annuity, so make sure you understand the surrender charges that are written into your contract.

[00:04:29] The federal government also charges a 10% penalty if you withdraw any of the returns or profits of your annuity before the age of 59 1⁄2. If you plan to leave your money in the annuity until retirement age, then these penalties are not an issue. Something to be aware of.

[00:04:47] Annuities aren't as flexible as other forms of retirement that may let you borrow or withdraw for emergencies or in other special cases. Why I cashed out my annuity. The thought of only making 4.5% of my money was all I needed to cash out my annuity.

[00:05:06] I was too young and there was too much time on my side to be capped at such a low rate. Ironically, many investors drool over making 4.5% nowadays. When I called the insurance company to inform them of my decision, they warned me about

[00:05:20] the penalties that I would have to pay and how I may not ever get such a high rate. It didn't matter. The decision was made. I was taking the money and opening a Roth IRA. Should you buy an annuity?

[00:05:33] If you're young and don't mind some fluctuation in your investments, it's hard for me to make the case that an annuity makes sense. Especially now since interest rates are so much lower. Now, if you absolutely hate the market and you love everything about the word guaranteed,

[00:05:49] then annuities might be right up your alley and we can help you obtain quotes for different annuity plans at best to meet your needs. Remember, annuities are a long-term investment, so educate yourself before investing in one.

[00:06:03] The bottom line is an annuity the worst investment a young person can make. The decision to invest in an annuity as a young person hinges on individual financial circumstances and long-term objectives. While annuities provide a traditional route for older individuals with substantial savings

[00:06:22] to secure additional retirement funding, they may not offer the same advantages for younger investors. Particularly, fixed annuities seem to lack appeal due to their limited growth potential. The appeal of Roth IRAs and 401ks due to their tax benefits and flexibility often outweighs that of annuities.

[00:06:42] However, if a young individual has a solid financial footing and has already significantly funded other retirement accounts, exploring variable or equity-indexed annuities as part of a diversified retirement strategy might be a consideration. Nonetheless, the associated penalties with early withdrawal from annuities underline

[00:07:03] the importance of thorough understanding and careful contemplation before venturing into such long-term commitments. You just listened to the post titled, Is an annuity the worst investment a young person can make? By Jeff Rose of goodfinancialcents.com. And I'll be right back with my commentary.

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[00:08:30] That's M-O-N-A-R-C-H M-O-N-E-Y dot com slash OFD for your extended 30-day free trial. The only reason I can think of why a young person might buy an annuity is because they don't understand or aren't comfortable with investing. Annuities are insurance products with contracts issued by life insurance companies.

[00:08:55] So it's more of a risk transfer strategy than it is an investment. And many people don't consider it an investment because when you buy an annuity, you immediately turn over 100% of your principal to purchase upfront the right to collect an amount of

[00:09:10] income from the insurance company for the rest of your life. Because it's an insurance product that's often layered with complexity and fees, annuities are often criticized for the high commissions sellers of annuities receive. Additionally, the returns on annuities can be relatively low compared to other investment

[00:09:30] options like stocks, mutual funds or real estate, which offer higher growth potential over the long term. Young investors with time on their side can afford to take on more risk in pursuit of greater returns.

[00:09:44] If you're already doing well investing in a 401k and or Roth IRA, why not continue with an after tax brokerage versus an annuity? And if it's due to wanting to decrease volatility in a portfolio, perhaps addressing the asset allocation is more appropriate.

[00:10:04] And that should do it for today. Thank you for being a subscriber or follower of the show and sharing it with others. It really goes a long way to keep this podcast going. Have a great rest of your day and I'll see you tomorrow where optimal life awaits.