7 Common Annuity Mistakes & How to Avoid Them

Not Naming a Beneficiary

When you buy an annuity, many investors make the mistake of not naming a beneficiary. While this may not seem particularly important at the time, having an annuity with no named beneficiary in your contract could create a major headache for your heirs down the road.

Each type of annuity contract has its own defining features, but generally speaking, when you name a beneficiary, they are entitled to your annuity’s balance when you die. This is often paid out as a lump sum or in a series of payments.

However, if you have no listed beneficiary or death benefit in your contract, any remaining cash will likely remain with the insurance company after you die.

If you have a death benefit as part of your contract but no listed beneficiary, your annuity may simply become part of your estate. This means your heirs will have to go through the probate process before they can access its value.

Annuities are typically exempt from probate, so failing to name a beneficiary can eliminate one of the key advantages of an annuity contract.

Failing To Best Protect Your Spouse

Many annuity customers purchase a product in the hope of protecting not only themselves but their spouse, as well. However, there is much more to consider when your spouse is your beneficiary.

For example, spousal continuation allows your spouse to become the annuity owner after you die. The product remains active, functioning for your spouse exactly as it did for you.

However, spousal continuation is only allowed if your spouse is the sole beneficiary. If, for example, you name your spouse and children as beneficiaries, then your spouse’s only option upon your death would be to split the annuity’s remaining value.

You can also select the account structure that best benefits your spouse. A joint and survivor annuity, for example, can be tied to two people so the contract remains active even after the first person dies.

Failing To Do Your Homework

One important thing to remember about annuities is that they typically require time and research before purchase.

These are complex financial instruments that can provide a lot of value to buyers, but they are not always easy to understand if you are new to these contracts. Because of this, many investors make the mistake of signing up for a product they don’t fully understand.

This is why it is critical to work with a financial advisor. Combining your own research with the expertise of an insurance professional or agent helps ensure you find the right type of annuity that will best meet your future needs.

Annuities are a complex financial product but the biggest mistakes people make are usually simple unforced errors like overlooking confusing terms, performance data, or relevant protection features for yourself or your heirs. Pay attention to the details of the contract because everything you need to know is in there.

What should you do if you don’t understand what you are reading? Ask as many questions as needed to feel comfortable and if you don’t get satisfactory answers that clear it up, then its time to go in a different direction.

Stephen Kates, CFP®Principal Financial Analyst for Annuity.org

Stephen Kates, CFP® is a personal finance expert specializing in financial planning and education. He serves as the Principal Financial Analyst for Annuity.org, where he delves into industry trends to support consumers and financial advisors on wealth management, annuities, retirement planning, and investing.

Not Understanding Surrender Charges

The surrender period is a key aspect of purchasing an annuity, so it is important to understand when and how you will have access to your funds again.

Annuities are typically multi-year products. This means that if you withdraw cash early during the surrender period, you will likely face a penalty.

Surrender periods typically last several years, with a penalty that decreases each year. Therefore, it will be much more costly to withdraw money in Year 1 of a contract than in Year 5.

The exact penalty varies by product. However, you can typically withdraw 10% of your annuity’s value without incurring the penalty.

By knowing when you can access your money, you can avoid a situation where you desperately need your funds but cannot access them without a hefty penalty.

Choosing the Wrong Type of Annuity

There are several types of annuities that each have their own pros and cons. Annuity refers to a broad range of products that operate in very different ways.

Annuity Types

The right customer for a variable annuity, for example, may have nothing in common with someone wanting to purchase a single premium immediate annuity.

To avoid purchasing the wrong type of annuity, prioritize your financial objectives over a specific product. Whether you aim to grow your money with minimal risk or convert a lump sum into immediate payments, keeping your goal in mind will guide you to the best option for achieving it.

Paying High Fees

Be sure to review all annuity fees and commissions for each product, and compare it against other options.

Variable annuities, for example, are often associated with higher and more numerous fees. A simple product like a MYGA, on the other hand, likely shouldn’t have a lot of bells and whistles attached to it.

Working with a reputable financial advisor helps ensure you don’t end up purchasing a product with unreasonable or exorbitant fees.

Timing the Market

Attempting to time the market is a common investment mistake that extends beyond annuities. The truth is that because rates constantly fluctuate, it can be very difficult to determine the best time to buy.

You may miss out on an attractive annuity rate because you expect it to climb, only to see it decline instead.

One annuity strategy that helps with market timing is laddering your annuities. Instead of investing all of your funds into just one annuity, you can split the money between different annuities. When you stagger their maturity dates, you can help ensure continued access to your funds in case of a future financial emergency.

This also lessens your risk by allowing you to follow movements in the market. As your earnings grow, you can set up future payments such that your income grows over time.