What About Annuities?

***Updated for 2024***

When I started researching annuity funds, I wondered why I, along with many others, are offered them as opposed to, say a 401k. There are some major differences, and I thought highly (still do) of 401ks even though I’ve never had one. Ever.

Throughout my working career, I’ve never been offered an opportunity to have a 401k, much less contribute to one. As I previously wrote, when I began to research retirement vehicles and how to maximize them, I found plenty of information on 401ks. In fact, most retirement information is on 401ks and IRAs. I read where people would max out their contribution limit on both ($23,000 & $7,000, respectively for the year 2024) and still look into other ways to save for retirement – a delightful problem to have for sure.

 

Related: Read The Ubiquitous 401k, Business, and American Wealth

 

And what do most people have? No retirement savings at all.

I didn’t want that to be me. I didn’t want to have to worry about money when we retired, so I looked into additional retirement vehicles and how to use them.

Though the contribution rate for the 401k is enticing ($23,000, and that is what an individual can put into it; that doesn’t even consider the employer match, which is free money on the table), it is also an employer-based plan – and as such, available to me. I sought things I could do on my own, and sadly, the standard 401k was not an option.

Then I looked into Individual Retirement Accounts (IRAs). The traditional option has you placing pretax money in your account, and the Roth option deals with after-tax money. There are other distinctions, but how they deal with taxes is primary. The contribution limit, in my opinion, is low; $7,000 a year for 2024. This seemed very low to me, and I thought if all I had at my disposal was an IRA for retirement, it was better than nothing – so I opened two Roth IRAs, one for me and one for my wife, with a total contribution limit of $14,000 yearly. Even then, after you consider the time one can invest in an IRA, I still think it’s low and wondered how people saved additional money. After all, what if a person isn’t offered any of the traditional vehicles most think about when it comes to retirement (pension plan, 401k, 403b, etc.)?

What is an Annuity Fund?

Enter the annuity.

So, exactly what is an annuity? I like Vanguard’s definition here:

”An annuity is a financial product typically used by investors to save tax-deferred for retirement or to generate regular income payments, helping to replace a paycheck in retirement. Annuities are insurance contracts whose payments are guaranteed by the company issuing the contract.” (emphasis mine)

 

The two main categories of annuities are the variable and the income. Basically, they deal with how the insurance gets the money, and you deal with taxes. (You might have seen annuities divided up into immediate and deferred, but I prefer variable and income)

The variable annuity (which is what I and many others have – those of you in a building trades union), you defer taxes until you withdraw money; in short, it looks a lot like a 401k in that you can defer taxes until you retire, allowing your money to grow into a nest egg for those golden years.

In typical, more well-known retirement plans (401k, 403b, etc.), contributions are made, and they are either tax-deferred or you’ve already paid taxes, and your money is tax-free. The money is invested and you hope it grows (it will) into a powerful vehicle for retirement. When you retire, you hope to have enough in your account to live off of so you don’t outlive your savings.

With a variable annuity there are many similarities (to the 401k, that is). Money is contributed tax-deferred and invested. Over the life of your working career, the money grows (from contributions, investments, and compound interest), and the balance can get to be quite large. I’ve heard of guys who have over 2,000,000 in their annuity fund and here’s the best part: their annuities were meant to be a supplemental retirement account! How a person chooses to take their annuity at retirement is up to them; either roll it over to another account for lower fees and more management (which may not always be possible), take it in one lump sum (which is not advisable since it is one hefty tax payment), or they could annuitize it. Annuitization is taking what you have in your annuity and converting it into payments, either for a specific period of time or a lifetime, depending on your funds and needs.

FYI: you’re basically turning your annuity into ANOTHER pension plan.

The other main type of annuity is income. A person with a lump sum of money gives it to an insurance company and, in turn, receives monthly payments until they die. The larger the payment and the longer the insurance company has to make money off it, determines what their monthly payout will be.

If you talk to investment professionals, THIS type of annuity – the income variety – is the one they are familiar with. Almost every financial person I’ve spoken with or read confirms this. Collectively, they do not know or understand the annuity fund the building trades have because they don’t deal with them. Just a little FYI for you.

Within these two main types exist other subtypes, but overall, they fit in either the variable or income range. In essence, then, annuities are pensions you can buy, either short-term or long-term term, and the amount of money you receive per month depends on the amount of money you have given the insurance company.

 

The good, the bad, and the ugly about Annuity Funds

 

 

In order to paint a robust and complete picture, all the relevant information is presented, whether it paints annuities in a positive light or not, so take a look at the following below:

 

The good

 

For starters, you do not have to begin withdrawing your money in an annuity at a certain age like you do with a traditional IRA. So long as you do not draw before 59 1/2 (which comes with a sizable penalty), age limits play no part here.

Earlier, I wrote annuities have similarities with standard retirement accounts, and they do: a major one is they allow you to defer taxes until retirement (when you draw out your first payment). This is a big one and should not be overlooked.

A HUGE benefit they have over the well known retirement accounts is there is no limit on how much money YOU can put into an annuity. Currently, a 401k has a contribution limit of $23,000 for the 2024 year. The same limit applies to the 403b, and the IRA limit is abysmally low at $7,000 per year. An annuity has NO limit, AND the money grows tax-deferred THE ENTIRE TIME. Furthermore, there is no income limit; no matter how much money you make, you can contribute to an annuity. Compare this to some who actually make too much money and are unable to contribute to certain retirement accounts (Roth IRA for example), and it is certainly a nice bonus.

Another benefit is the income annuity (and its various categories) could provide an individual with income for life, depending on how it’s structured. A person gives the insurance company a lump sum, and based on the amount of time and amount of money, a monthly payment is figured, and that is what will be received, for the rest of their days. If you live longer than you thought, the monthly payment still keeps rolling in, no matter what. It’s this type of annuity and benefits that I have found the most research on. That doesn’t mean it is the best kind of annuity – just the most common.

 

The bad

 

The number one thing I have seen people dump on annuities for is the fees. The figure I have seen tossed around is 2% to 4% in fee cost. This doesn’t sound like much when your pot at the end of the rainbow is small, but when your pot grows, so do the fees. The fees associated with the annuity aren’t always as bad as others make it out to be, though, especially if you have an annuity that’s managed along with others in the same plan as opposed to you opening one solo. Fees can and often are negotiated when cases like this arise. And, sometimes, the fees associated with 403bs (the nonprofit equivalent of the 401k) and 401ks are not stellar, either. I listened to a podcast a couple of years ago where a guy said that after a while working at the same place, he quit so he could roll over his money from his 403b to his IRA to avert higher fees and less-than-desirable investment options.

* Update: I recently received an update from the admin of my annuity fund dealing with admin fees. Currently, they are $12 a month, but they were soon to be reduced to $8! The reason: more individuals were being merged into the annuity plan. Going from $144 a year to $96? Sign me up anytime. *

Another downside to annuities is the ways taxes manifest themselves. Yes, the taxes are deferred – or postponed- until you draw your money from the annuity, but once you do, your money is taxed at a higher rate. Allow me to explain:

The capital gains tax (which is a tax on the gains of an investment) has a cap of 20%, whereas your highest income tax bracket is 39.6. Guess which one your money from an annuity is taxed at when you withdraw it in retirement? You guessed it…the income tax rate. Now, it may not be at the 39.6 % rate, but it is still taxed at the regular income tax level as opposed to capital gains. 

But guess what? 401ks are taxed THE EXACT SAME WAY: as income. This perceived negative loses some steam when compared to more mainstream retirement vehicles.

Another negative is you typically can’t touch the money you put into an annuity; once you give it to the insurance company, it’s hands off until you can draw it, whereas you can tap into 401ks and other retirement vehicles (albeit with a penalty). There are cases where you can possibly get your money back from an insurance company depending on the annuity you purchased, but you will pay a hefty surrender fee – not the best decision when the goal is to save money for retirement – not give it away.

The complexity of some annuities is sometimes cited as a negative. If you don’t understand something, it’s typically a good idea to steer clear of it. While I believe most people have little to no retirement savings because they are not disciplined enough to save themselves, I’m willing to bet an even larger number of people have very little knowledge of how their retirement plans work or how they are structured. Some annuities are extremely complicated, so much so investment professionals can have difficulty understanding them. Simplicity is, in most aspects of our lives, to be desired, and that is certainly true for retirement accounts also.

Another drawback for annuities of any size or scope is the guarantee the insurance company provides is only as strong as the insurance company is; there is no FDIC (Federal Deposit Insurance Company) to provide your money with protection. This is why it is important for someone to do their homework when purchasing annuities and picking a strong and durable insurance company to purchase from. Now, without complicating matters, there is some insurance for investors due to state regulations, but personally, I would approach it as if there were no protection and tread lightly. If you have a very large sum to buy an annuity (let’s say $1,000,000), I would spread it around to different insurance companies to diversify that investment.

 

The Ugly

 

Ugly is the information about annuity funds and retirement in general for many like me. The vast majority of information out there is geared toward someone who has a decent lump sum of money to invest (let’s say $100,000 or more), and that individual is concerned with outliving their retirement savings. So they buy an annuity (retirement insurance) to have a constant retirement stream for the remainder of their days. They deal with those fees, rates, and investment constraints most write about, and overall they are potentially shortchanged.

This, however, is not how the situation is for many like me. For those of you who have an annuity fund and are contributing to it (more accurately, have a set amount of money contributed to it due to collective bargaining) regularly as a supplementary retirement account, you know you are different. Your fees aren’t as bad, your options are better, and you have time to grow them into powerhouse vehicles for retirement.

Another ugly is the perceived diversification one gets from having retirement savings in annuities. When other retirement vehicles are maxed out some opt for annuities to add additional money into retirement – a good idea. For diversification purposes, however, it might not be. No matter what vehicle one chooses to save and invest using, the money is invested into the market which has risk. Trying to avoid risk by placing money into insurance companies doesn’t work because they are going to invest the money given to them in the market, and their worth is wrapped up in the market as well. It’s not a smart move to hide it under a mattress since inflation eats away at your purchasing power – so investment, in its most basic understanding, is a roll of the dice, but a necessary one to have a chance to turn your hard-earned retirement savings into more. Researching what you can about the different vehicles is a smart move on your part, and helps us make educated decisions. This is but one of the many reasons this website was started in the first place.

 

Conclusion

 

All in all, annuity funds are not as bad as they are made out to be, but they are not perfect, either. I know ironworkers who have substantial amounts of money in annuity funds as supplementary retirement accounts. Because they are part of a large group of managed retirement assets, their fees are negotiated lower, and overall management is better. This negates much of what people write about concerning fees. Since a lot of guys in the skilled trades find themselves in the same situation as I am, they do not have 401ks, 403bs, 457, TSPs, or other types available to people. Instead, they have a multi-employer pension and a supplemental retirement account in the form of a variable annuity (both negotiated by a collective bargaining agreement). If there exists the smallest amount of discipline, IRAs are utilized to their yearly limit ($7,000 if you are under 50 and $8,000 if over 50 in 2024), which is a feasible endeavor for many. For any others who want to save beyond that, their options are limited to additional annuities, direct investing in various options, or taxable investment accounts – from places like Acorns or Betterment. Annuities allow an individual tax-deferred retirement savings while the rest do not; you will pay taxes on them yearly.

Honestly, trying to decide what other retirement vehicles you have at your disposal is a good problem to have. It says you have the discipline to save and are looking to increase your retirement security more; I say this is a good thing. The lack of additional vehicles to save money for retirement is something I seriously hope will change in the future, but for now, limited options prevail. Let those who are serious about retiring with some measure of comfort educate themselves, invest wisely, and eat steak in those golden years.

 

***Addendum to the above after initial publishing***

 

One of the most asked questions – for those who have annuity funds from a Collective Bargaining Agreement (CBA) is whether they can elect to contribute to it with money from their check. This necessitates we explain what happens currently:

Contractors and union members negotiate a contribution rate, typically per hour, and that is paid into your annuity fund – which is then managed by trustees. When your fund is managed (or directed) by trustees, it’s often the answer that no, you cannot elect to contribute more money into the annuity fund other than what’s negotiated. 

However, if your trustees explore what is known as “member-driven” annuity funds, then yes, it is a possibility. Currently, I only know of one fund that is currently doing just that. The contractor pays $6.00 an hour into the member’s annuity fund; the members then have the choice to contribute up to another $6.00 – bringing the possible total to $12.00 an hour.

For those not doing the math, that’s going from $12,480 a year to a potential $24,960 a year. 

Not bad AT ALL.

This is, of course, all done with pre-taxed dollars; you WILL pay taxes down the line. You know what they say, there are only two things for sure: death and taxes.

This takes intentionality, though; engaged in their respective local and trade, as well as some financial prudence and literacy. 

 

Ultimately, this will be part of a larger “Retirement Series” on both the website as well as the podcast. It takes time, though, to put out any solid content, and for the retirement portions, I have a guest in mind.

Stay tuned!