Annuities: Separating the Good From the Bad
- christopheromalley3
- Oct 4
- 7 min read
How to Identify the Right Type, Avoid Hidden Traps, and Know When an Annuity Makes Sense — or When It’s a Red Flag
Introduction: Why Everyone Seems to Be Selling Annuities
If you’re approaching or already in retirement, you’ve probably been pitched an annuity.
It might have come from your financial advisor, your insurance agent, or a dinner seminar with promises of “guaranteed income for life”, “market upside with no downside”, or “a 7% guaranteed return.”
Sounds too good to be true?That’s because, in most cases — it is.
Annuities are one of the most heavily marketed, least understood financial products in the world. They can be powerful tools when structured correctly, but they can also lock you into inflexible, high-fee contracts that underperform and eat away your savings.
This article breaks down what annuities really are, the good, the bad, and the dangerous, and when they might (or might not) belong in your Family Endowment or retirement plan.
1. What Exactly Is an Annuity?
At its core, an annuity is a contract between you and an insurance company.
You give them a lump sum of money. In return, they promise to pay you income — either right away or in the future — usually for life.
Sounds simple enough. But behind that simplicity lies a maze of:
Fees, riders, and surrender penalties
Complex interest-crediting formulas
Marketing language that can blur the truth
There are three main categories of annuities:
Within each type, there are multiple variations, riders, and income guarantees — making apples-to-apples comparisons almost impossible for the average investor.
2. Why So Many People Buy Bad Annuities
Most people don’t buy bad annuities on purpose — they’re sold them.
The annuity industry pays some of the highest commissions in finance — often 5–10% upfront, sometimes more. That means on a $500,000 contract, the agent could make $25,000 to $50,000 immediately.
This creates an obvious conflict:Advisors may recommend annuities not because they’re best for the client, but because they’re best for the advisor.
And because most contracts are designed to tie up money for 7–15 years, you can’t easily get out once you realize it wasn’t the right fit.
Common red flags:
“Bonus” rates that vanish after the first year
“Guaranteed income” that only applies if you annuitize (giving up control)
“Market upside” with caps so low you barely outpace CDs
10+ year surrender periods
Limited liquidity (often only 5–10% withdrawal allowed per year)
3. The Promise vs. Reality: Why Returns Often Disappoint
A major misconception is that annuities offer “guaranteed returns.”
In truth, they usually offer guaranteed income, not growth. That’s a critical difference.
For example:If you buy an indexed annuity promising “up to 10% returns”, the reality might look like this:
Year 1: Market up 15%, you get 5% (due to cap)
Year 2: Market flat, you get 0%
Year 3: Market down 20%, you get 0%
Year 4: Market up 12%, you get 4.5%
Over four years, you’ve averaged less than 3% — before fees and inflation.Not bad for safety, but nowhere near what was implied in the sales pitch.
4. When Annuities Do Make Sense
Despite all this, not all annuities are bad. In the right hands, they can fill specific needs extremely well.
Here’s when annuities make sense:
✅ Health Concerns or Life Insurance Ineligibility:If you can’t qualify for life insurance due to health, an annuity can create guaranteed lifetime income or provide survivor benefits.
✅ Longevity Protection:For retirees who fear outliving their money, income annuities can create a baseline of guaranteed income for life, like a personal pension.
✅ Short-Term Fixed Income:Fixed annuities can outperform CDs for 3–5 years with principal protection.
✅ Tax Deferral for Non-Qualified Money:If you’ve already maxed out IRAs and 401(k)s, annuities allow additional tax-deferred growth.
✅ Market-Protected Accounts:Some indexed annuities serve as bond alternatives for conservative investors seeking principal protection and modest growth.
But even in these situations, the structure, company, and timing matter immensely.
5. The Hidden Costs Most Investors Never See
Annuities often carry layered costs that erode returns. These can include:
Mortality & Expense (M&E) Fees: 1.25%–1.75% annually
Administrative Fees: 0.10%–0.25%
Fund Subaccount Fees: 0.50%–1.00%
Rider Fees: 0.75%–2.00% for “guaranteed income” or “death benefit” riders
Total costs can reach 3–4% per year, which means your account must earn 4% just to break even.
By contrast, an IUL or Family Endowment structure often delivers similar guarantees with far higher liquidity, tax-free growth, and no surrender restrictions.
6. The Longevity Illusion: “Guaranteed for Life” Isn’t Always What It Sounds Like
Many annuities promise “income for life,” but there’s a catch:The income is your own money paid back slowly — not a new return on investment.
Here’s an example:A retiree invests $300,000 in a lifetime income annuity that pays $18,000 per year. That’s a 6% payout rate — sounds great, right?
But run the math:You’re just getting your own principal back over 16–18 years.Only after that period does the “insurance” portion kick in — if you’re still alive.
It’s not 6% growth; it’s a 6% withdrawal. There’s no new wealth being created.
That’s why these products often make sense only when used to protect against longevity risk, not as growth or wealth-building tools.
7. Why Health and Life Insurance Qualification Matter
Many retirees turn to annuities because they can’t qualify for life insurance or tax-advantaged income strategies.
If your health disqualifies you from life-based plans (such as IUL or private pension structures), an annuity may be the next-best fallback.
But for healthy individuals, annuities often represent an opportunity cost — tying up capital that could be working far harder in a Family IPO or tax-free income strategy.
In other words, annuities can be a solution of last resort, not the first choice.
8. The “Bonus” Myth and Rate Gimmicks
Annuity ads love to promote “10% bonus!” or “7% guaranteed!”
Here’s what those really mean:
The “bonus” usually isn’t real money — it’s a bookkeeping credit applied to an income base (not your cash value). I compare it to store credit.
The “7% guaranteed” is not a return — it’s an internal roll-up rate used to calculate future income payments.
You can’t actually withdraw that “guaranteed” amount.
It’s a numbers game. The insurance company controls every lever: caps, spreads, participation rates, and fees. That’s how they can make big promises without ever losing money themselves.
9. Liquidity: The One Feature You’ll Miss Most
When you invest in an annuity, your money becomes illiquid.
You typically face:
7–15 year surrender periods
10% early withdrawal penalties
IRS penalties before age 59½ (for qualified contracts)
That means if you need access to your funds for emergencies, opportunities, or family support, your money may be locked up and inaccessible.
This is especially dangerous for business owners and retirees who want flexibility to respond to tax changes, new investments, or family needs.
By contrast, strategies like the Family Endowment Plan or cash-value life structures keep your assets liquid, growing, and tax-free — not trapped behind surrender walls.
10. The Tax Trap
While annuities grow tax-deferred, withdrawals are taxed as ordinary income, not capital gains. This means your tax bill can be much higher in retirement — especially when combined with RMDs, Social Security taxation, and Medicare surcharges.
Additionally, if you leave annuity assets to heirs, they pay income tax on all deferred gains. There’s no step-up in basis like you get with brokerage or real estate assets.
In contrast, tax-free vehicles like IULs, Roth conversions, and Family IPO structures eliminate that future tax burden entirely.
11. The Good: When Annuities Are Actually Excellent
There are situations where a well-designed annuity is genuinely powerful:
Immediate annuities for those with no pension, seeking predictable income.
Short-term fixed annuities (3–5 years) during high-rate environments.
Deferred income annuities (DIAs) for longevity protection past age 80.
Simplified issue annuities for those uninsurable for life coverage.
In these cases, annuities serve as a risk transfer, not an investment.They can stabilize income for those who can’t self-fund or qualify for better tax-free options.
But the key word is fit — they’re tools, not solutions.
12. The Bad: When Annuities Destroy Wealth
Unfortunately, most annuities fall into this camp.
They:
Lock up capital during the most flexible years of retirement
Create taxable income streams
Underperform inflation
Limit access to your own money
Never really grow - especially the Indexes that have multipliers - or the suckers bet
That’s why the majority of sophisticated planners use annuities sparingly — if at all — within broader, tax-efficient endowment strategies.
13. The Smarter Alternative: The Family Endowment Approach
The Family IPO or Family Endowment Method solves for the same goals annuities promise — but without the downsides.
Instead of handing your money to an insurance company, you create your own endowment — a family-controlled system that:
Earns tax-free income for life
Matches deposits every year
Passes income tax-free to future generations
Keeps your capital under your control
That’s what annuities want to be — but can’t, because they’re designed to protect the company, not you.
14. The Bottom Line: Annuities Aren’t Evil — Just Misused
Annuities aren’t inherently bad. They’re just frequently misunderstood and oversold.
Used strategically — for guaranteed income, health challenges, or short-term stability — they can play a small but valuable role.
Used broadly — as a substitute for true planning — they can quietly erode wealth, flexibility, and legacy.
That’s why understanding the difference between good and bad annuities is one of the most valuable financial lessons you can learn before retirement.
15. Your Next Step: Audit Before You Commit
If you already own an annuity — or are considering one — have it audited before you commit.
We routinely uncover:
Hidden fees and surrender penalties
Underperforming contracts that can be exchanged tax-free
Opportunities to convert taxable income streams into tax-free family wealth
Before you lock up your money, see whether that annuity truly serves your goals — or whether it can be restructured into a tax-free, flexible, and generational plan that multiplies what you’ve built.
📞 Schedule a Private Consultation
We’ll show you exactly:
Which parts of your annuity are working
Which are draining wealth
And how to create a structure that grows, protects, and multiplies your assets tax-free for life. 630-834-3794
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