A client of mine recently asked the following question about annuities:

A retired friend of mine is heavily invested in income annuities. He claims that these insurance products provide a nearly tax-free income stream that allows him to avoid the income penalties associated with Social Security, and with less risk. Do you know anything bout these products?

My Reply:

Regarding annuities, they are not all they’re cracked up to be. They have high internal costs and gains are taxed at ordinary income rates rather than capital gains rate. If your friend is excited about tax savings from social security, he may be talking about a fixed annuity, in which case, he may be paying less tax, but more than likely did not, or will not make returns that will safeguard him from inflation. In other words, he is making interest rates not market rates. This may be okay for a portion of a plan, but you can usually do the same thing without the added costs.

Also, in the world of annuities, not all things are equal. As you know, some annuities have far lower expenses than others. Some are no-load. Some have low expense investment alternative such as your T. Rowe Price or Vanguard annuities. Recently, Jefferson National released an annuity with a fixed insurance charge. This is part of the high M&E expense ratios in all annuity. M&E, or mortality and expense charges pay for the insurance guarantee, commissions, selling, and administrative expenses of the contract.* A fixed insurance charge of $20 a month, coupled with low index type investment, and no-load or no-commission charges will actually start to get my attention with an annuity. I don’t like them, but they may be appropriate for a small portion of your portfolio when the time comes.

For example, if you are retired, have passed the period of retirement where you are able to act like a young retiree, you may feel more safe with a guaranteed portion of income, despite the cost. At this point, the security knowing that you aren’t going to run out of money becomes very appealing. Even then, it isn’t recommended you put all your eggs in one basket.


I would also like to add the following from Social Security.gov

Pension payments, annuities, and the interest or dividends from your savings and investments are not earnings for Social Security purposes. Only your earned income–that is, your wages or net income from self-employment–is covered by Social Security.

You may have to pay income tax on pensions, annuities, interest or dividends, but you do not pay Social Security taxes on those types of income and they are not on your Social Security record.

In other words, annuities aren’t the only savings not taxed by social security. Your IRA or 401k withdrawals are not as well.

Within the next decade we are going to see a lot of people placing their life’s savings in the hands of their financial advisors as they seek advise on investing their entire life’s savings. Annuity salesman will tout that their products are the only financial plan you need. This is scary. Jany Bryant Quinn illustrates the pending need for advise in her Newsweek article entitled: Planners Wanted ASAP. You might be interested to note that the “ideal” financial planner she encourages most of these boomer’s to seek is surprisingly familiar. If you know someone who might fall prey to these salesman, like Ms Quinn, you might encourage them to seek a qualified “fee-only” certified financial planner.

Rich Feight, CFP
Rich Feight, CFP

Hi, I'm Rich Feight I'm a fee-only Certified Financial Planner, successful business owner, and self-made millionaire that knows how to beat the system and become wealthy. I have a lot of clients that have done it too. I'm also pretty good at finding that ever-elusive work/life balance so many of us strive for. Lucky for you I have an abundant mindset and give all my knowledge away on my blog. So if you want to know what it takes to become a millionaire, follow me.

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