8 Reasons Not to Buy an Annuity for Railroad Retirement

Welcome, readers, to another installment of the Highball Advisors Railroad Retirement Whiteboard. I'm John McNamara from Highball Advisors, and today we'll be discussing annuities. While financial advisors may recommend annuities to certain individuals, I firmly believe that Railroaders should steer clear of them. Let's go through the reasons why annuities may not be the best choice for you.

First and foremost, purchasing an annuity provides guaranteed income. You give a lump sum or make regular payments to an insurance company, and in return, they promise to provide you with an income stream in the future. While this may sound appealing, Railroaders already have access to the best annuity available—the tier two portion of Railroad Retirement. Combined with any pensions you may have, you already have a substantial amount of guaranteed income in retirement. Therefore, an additional annuity is unnecessary. If this satisfies your needs, feel free to stop reading here. However, I have seven more reasons to consider.

Reason number two is insufficient liquid savings. Buying an annuity often requires ongoing payments, and if you don't have enough funds readily available, you'll have to keep putting money into it. This can be a burden and a reason to avoid annuities.

Next, number three, is health concerns and shorter life expectancies. Remember, when you purchase an annuity, you're essentially exchanging a sum of money for a future income stream. If you don't anticipate living long enough to enjoy that income, there's little reason to invest in an annuity. Some might argue that they can pass it on to beneficiaries, but there are more efficient ways to leave a legacy than through an annuity, which I'll explain shortly.

Number four brings us to surrender charges. Once you've handed over your money, you may face penalties if you need to withdraw it within the first seven to ten years. Additionally, annuity withdrawals are subject to the "last-in first-out" method, meaning your earnings are taxed as ordinary income. If you withdraw funds before the age of 59 and a half, there may also be a tax penalty.

The limited growth potential of certain annuities is reason number five. Some annuities, such as index annuities, cap your risk both on the downside and the upside. While this protects you from major losses, it also means you miss out on significant market gains. Variable annuities, which invest in equities or mutual funds, often come with high costs that can eat into your returns. It's crucial to carefully examine the costs associated with annuities.

Number six is inflation. Fixed annuities with guaranteed returns may struggle to keep pace with inflation. Purchasing an inflation rider for your annuity incurs additional costs, further reducing your overall return.

High fees and expenses make up reason number seven. While annuities may seem appealing on paper, the reality is that they come with significant fees. Mortality and expense fees, agent commissions, rider expenses, and sub-account expenses all chip away at your investment's potential return.

Returning to an earlier point, reason number eight revolves around your estate planning objectives. Annuities lack a step-up in basis, unlike regular taxable accounts. This means that if you pass on an annuity to your children, they will be subject to ordinary income tax on the difference between the purchase price and the contract value. From an estate planning perspective, annuities may not be the most sensible option.

So those are my eight reasons to reconsider purchasing an annuity. My advice is to avoid attending those annuity sales dinners and declining the free meal. Instead, focus on alternatives that better suit your needs. If you currently own an annuity, feel free to reach out to me. We can explore options like exchanging it for a fee-only annuity or finding other strategies once you've passed the surrender charge period. These are topics we can delve into during our Boarding for Railroad Retirement process, designed for those approaching or in retirement. Don't forget to sign up for it. Click the notification bell to stay up to date with our latest videos. Until next time, stay safe, stay on track, and take care. Goodbye, everyone.

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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. Highball Advisors encourages you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Highball Advisors, and all rights are reserved from Highball Advisors, and all rights are reserved.