Annuities may have a place in your retirement investing

Annuities have a lot of rigid terms that can work for or against you.

The main benefit of annuities is that they offer stable, predictable income. That may make them suitable for part of your assets, depending on your age, investment experience, the time you want to devote to your investments, your desire to leave an estate to your heirs and other aspects of your retirement investing.

The main drawback is that annuity payments stop when you die. But that’s not always the case. Read on for more details on the different kinds of annuities.

How annuities work

There are basically three types of annuities:

Term-certain annuities are payable to you, or your estate, for a fixed number of years. Your estate will receive the payments even if you die. You could outlive this type of annuity.

For a limited time only, sign up to get Pat McKeough's specific answers to your personal investment questions. Pat's proven expertise is available to guide the investment decisions of only a few new Inner Circle members. Click here to learn more about how you can benefit from membership in Pat McKeough's Inner Circle.

Single-life annuities are payable to you for as long as you are alive. These annuities may come with a minimum number of years of payments. If you die while the minimum payment period is still underway, future payments would go to your estate.

Joint and last survivor life annuities are payable as long as you, or your spouse, are alive.

3 ways annuities can hurt your retirement investing

Stable, predictable income is a plus for any retirement plan. However, annuities do have certain disadvantages that can lower your retirement investing income.

Here are 3 drawbacks you should keep in mind when deciding whether annuities are right for you:

1. Annuities are linked to interest rates: The rate of return you receive on an annuity is linked to interest rates at the time you buy it. That makes periods of unusually low interest rates, like today, an especially poor time for buying annuities.

However, if you want to buy annuities, you could buy one annuity a year for the next five years. That way, your returns will increase if interest rates rise as we expect.

2. Poor liquidity: Unlike stocks, it can be difficult or impossible to sell an annuity if you decide it no longer meets your needs. Moreover, you will likely get a low price for your annuity because the date of your death is uncertain.

3. Tax disadvantages: When you own an annuity, the income payments you receive are made up of interest and a return of your principal. The return of your principal is tax free, but the interest portion of the payment is taxed as ordinary income.

Ordinary income is taxed at a higher rate than returns on a stock portfolio. If you build your retirement investing portfolio as we recommend, part of your return would come in the form of dividends from Canadian stocks, which qualify for the dividend tax credit. The remainder would come in the form of capital gains, which are taxed at half the rate of ordinary income, and are only taxed in the year you sell.

A safety-conscious investment portfolio is often a better option than annuities

In the end, we think most investors would be better off building a retirement investing portfolio that contains the kind of high-quality, safety-conscious investments we recommend our Canadian Wealth Advisor newsletter, well balanced across the five main sectors of the economy (Manufacturing & Industry, Resources & Commodities, the Consumer sector, Finance and Utilities).

At the moment, we advise against buying annuities or long-term bonds. However, our view may change along with interest rates and inflation.

You can get our latest buy/sell/hold advice on dozens of safety-conscious investments suitable for retirement investing, as well as strategies you can use to increase your profits with lower risk in our Canadian Wealth Advisor newsletter. Click here to learn how you can get one month free when you subscribe today.