Is an Annuity the Worst Investment a Young Person Can Make?

Joseph Meyer
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Free Report on the Highest Annuity Rates for 2022

The Baby Boomers are aging, and so are their parents. The country’s Social Security system will face a big challenge in the next several decades as millions of Baby Boomers begin to retire. As they get older, their parents are also likely to retire. This means that consumer spending in the United States may come under pressure as people’s lifestyles change. Households becoming smaller, with just one or two retired parents, may mean fewer new homes, cars, and even smaller families.

This translates to less need for products and services, leading to stagnant economic growth and lower S&P 500 earnings.

To guard against this, people are looking for ways to fill the gap left by the diminishing payouts from Social Security and other public sector retirement plans. One way they can do this is to invest in an annuity.

What is an Annuity?

An annuity is basically a fancy, high interest savings account built around an insurance policy. It offers a relatively high interest rate but also typically requires a long-term commitment. As a result, it’s not something that a person of any age can just go out and buy right off the bat…but it can be an ideal vehicle for some investors…particularly those who are older and are drawing near to retirement.

As a practical matter, most annuities are purchased by people looking for ways to protect their savings against risk, or for people who have a goal of putting their money to work and want to guarantee a decent return. People such as these often look at annuity products as a way to achieve more control over their investments in two ways. First, they have fixed rates of return. Second, the payments (which are typically made monthly) are guaranteed.

Annuities are typically considered an allocation of a person’s assets, a sort of investment product that’s halfway between an investment account and a savings account. The main downside is that people looking to invest in an annuity face a high level of risk once they’ve put their money in. Additionally, the government can change the tax code at any time to drastically impact the rate of return that an investor sees from his or her accounts.

Young People and Annuities

Many financial advisors and software programs such as Quicken, while making recommendations on investments, will tell you that an annuity is the worst investment you can make. Unfortunately, many young people are told to put some of their money in annuities. Why?

Annuity Penalties – Read the Fine Print!

It’s no secret that an annuity is a bad investment for someone who is young. But what is often overlooked is the damage that can be caused over and above just receiving a low or negative rate of return.

This happens when a young person purchases an annuity with no intention of ever cashing it out. In that case, the annuity essentially becomes a tax on time at a rate of 3-5% per year (or 25%+ per decade).

Remember that time is easy to waste but hard to recover especially in retirement. When you are older, it’s impossible to go back in time and buy a second chance (with the same investment return).

To avoid this fate, consider FIRE as early as possible. That’s because the longer you can practice any form of financial independence the more likely you will be to make it and the more time you will have to enjoy retirement.

Why I Cashed Out My Annuity

I recently received a big check for my annuity. I had cashed it out early. It was a pretty big decision, but I’m a big spender, and I wanted this cash now.

It’s important to note that I could have waited to cash it out for a much larger sum. But I wasn’t willing to wait the three years I thought it would take for me to have the money. I wanted some new clothes for my new wardrobe, because my clothes were falling apart from age.

The main reason I cashed out, however, is because I was greedy. I wanted more, and I didn’t want to wait to get it. But that’s not how I got the money. I never would have had the money if I had never bought the annuity in the first place.

First off, I need to tell you what the annuity was and how I bought it. A few years ago, I was working, but only part time. I missed the days when I was working full-time with a steady paycheck. I wanted to do something about it, so I decided to shop around for annuities.

An annuity is a contract between you and an insurance company that you sell a portion of your future income for a lump sum “ today. The more income you get, the bigger the lump sum you can sell.

Should You Buy An Annuity?

What is an annuity? Simply put, an annuity is an insurance contract between you and a life insurance or long term care company. You make payments that are either partly or mostly invested by the company and in return, you receive guaranteed future incomes. It is usually referred to as an investment, although the money is eroding in value due to inflation every year. The average life expectancy of a 65 year old is about 80, and most annuities pay out for at least 10 years. Typically, it is sold as part of a retirement plan involving an employer or is sold directly by an insurance company.

Annuities usually have a few things in common with one another which is why they are lumped together in one category, but not all annuities are created equally. What you get depends on how much you invest and where:

Age and gender: Investing in the right age group and gender is critical to your success. If you die too early, you won’t get any returns on your investment. If you die later, your heirs can inherit the rest of the value.

Type: Depending on where you live, you can get fixed returns (usually 2-3%) or variable returns (usually 4-5%). Fixed returns are predictable and sound safe, but you earn less returns. Variable returns fluctuate with market movements and they can result in more income.