Ask an advisor: Should I dump my annuity?

January 19, 2023 6:48 PM

Annuities are enjoying record sales, but not everyone feels confident about their purchase.

Welcome back to "Ask an Advisor," the advice column where financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

This week's question is about annuities, which have been having an extraordinary year. These insurance products, which provide a pension-like income during retirement, tend to sell better during periods of economic instability — so perhaps it's no wonder they boomed in 2022. Last summer, annuity sales reached $80.7 billion, their highest quarterly total ever recorded. This shattered the previous record, which had been set just one quarter earlier.

But amid the bonanza, there's one annuity owner who's having a whiff of buyer's remorse. A public school worker in New York said she was offered the insurance product by her employer, the city's Department of Education, and she signed up. Seven years later, she's having second thoughts.

Read more: The Annuity Paradox

Specifically, the woman, who is aged 33, has a tax-deferred annuity (TDA), which has advantages and disadvantages: On the plus side, her contributions are not taxed until she withdraws them in retirement — when, presumably, she'll be in a lower tax bracket. On the other hand, her taxes upon withdrawal will be at her ordinary rate, and TDAs, like many annuities, are relatively inflexible — you can't swap them like stocks or funds and shift their holdings into other investment vehicles, such as an individual retirement plan. And if the owner decides to cash out early, in most cases they'll have to pay not only the income taxes on the money they withdraw, but a "surrender charge" as well.

Annuity.org, an industry-funded website, says that a deferred annuity "makes sense for people nearing retirement or for younger investors who have maxed out their retirement plans but still want to put money into tax-deferred retirement vehicles." It notes that such an annuity "limits your ability to repurpose your retirement savings — and can be very difficult to reverse if you change your mind."

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In this woman's case, no surrender charge is stipulated in the Board of Education Retirement System document her employer gave her, and she does not plan to withdraw any funds until she retires — probably around age 65, she said. There are no fees besides the contribution from her paycheck — as of now. The document says that annual expenses are "covered by a charge to contributing participants, currently $0," but it's not clear whether that fee might rise in future years. The woman said she paid no upfront fee, known as a front-end load. Nevertheless, she's beginning to have second thoughts. Here's what she wrote:

Dear advisors,

I am a 33-year-old occupational therapist at a New York City public school. When I was 26, my job offered me and my co-workers a tax-deferred annuity, provided by the Board of Education Retirement System. On the advice of my colleagues and without much knowledge of my other options, I signed up. I contribute 10% of my paycheck, out of a salary of $83,000. The return on the "fixed" program, which I chose, is supposed to be 7% (more information here).

Seven years later, I'm wondering if this was a good decision. Is this annuity enough by itself to provide for my retirement? Should I invest in something else to supplement it — or even replace it? I still have the option to stop contributing or to withdraw the funds. Or would that be a mistake?

— Hesitating in Harlem

And here's what advisors wrote back:

A no-brainer

Byrke Sestok, certified financial planner and founder of

Rightirement Wealth Partners

in Harrison, New York:

Easy question and answer. This TDA (tax-deferred annuity), with its 7% fixed rate of return, is one of the best investment deals available to retail investors. Compare that to a blended investment portfolio with a targeted rate of return of 7%. That portfolio would have significant risk, whereas your annuity has zero risk. It's a no-brainer. If I had this option available to me, I would put as much money into it as I can.

No, this is not enough

Derek Tuz, certified financial planner and partner at

Aegis Financial Partners

in Denver, Colorado:

Do you also get a pension? If the 403(b) annuity is the only thing you get, then no, it will not be enough for retirement. If the return is 7%, maybe you should put more than 10% into it. For retirement, you are going to need three legs on your stool: retirement accounts (e.g. annuity, 403(b), 401(k), IRA, etc.), government benefits (Social Security, state pension) and an after-tax account.

Keep it!

John Bovard, certified financial planner and owner of

Incline Wealth Advisors

in Cincinnati, Ohio:

Keep the annuity and continue to contribute to it. The tax deduction is great, and 7% is a good return. In addition to the TDA, you should also see if a 403(b) (like a 401(k) for educators) is available. A 403(b) would allow you to invest more aggressively and may even have a Roth option. If a 403(b) is not available, then supplement retirement savings with a Roth IRA.

Go variable, young woman

Ralph Bender, certified financial planner and CEO of

Enduring Wealth Advisors

in Temecula, California:

Kudos on a great start at a young age! You should already have roughly $70,000 in a tax-deferred account. In 30 years, that'll be over $500,000 without adding anything if interest rates don't change. But the rate is set by the legislature, so it's not guaranteed.

Given the current stock market valuations, I'd switch a substantial portion of future contributions from the fixed program to the variable program. For the next year, I'd put 100% of your contributions in the variable program, then reevaluate annually from there.

Any supplemental deferrals at this income level should probably go into a Roth IRA invested in stocks, which will establish a future tax arbitrage potential at retirement. Another 2% of income would achieve the 12% that some advisors recommend.

Finally, there's no holistic information about emergency reserves and non-retirement assets, but I'd recommend ensuring those are in place.

A good start, but more to do

Nicholas Bunio, certified financial planner at

Retirement Wealth Advisors

in Downingtown, Pennsylvania:

Hi there! My clients are 50+, so many do have annuities.

There is nothing wrong with an annuity. If the fixed portion is 7%, that's pretty good for minimal risk. But I would warn that the 7% is not guaranteed; it will go up and down. As interest rates go lower in the coming years, this amount will decline too.

The annuity itself is in an employer-sponsored plan and this isn't necessarily wrong or bad. We need to save for retirement, and starting young is great! But you need to review the costs of this annuity.

More than likely, since you're young, moving some over to the variable portion makes sense. More than likely, stocks will outperform this fixed amount over the next few decades.

But also, if the costs of this annuity are high, you can roll this over to an IRA and manage the funds yourself for a potentially lower fee. Or, if you have a different job in the future, roll over this money to a new 401(k)/403(b) type plan. Or hire an advisor!

And yes, you must save more for retirement. This annuity will probably not cover everything.