An annuity is an investment that pays a specified Cedi amount to the holder each period until it expires or the holder’s death. The investor pays a lump sum or a series of payments to an insurance company, which promises to make certain payments over time with interest or earnings. An annuity contract can be backed by fixed or variable securities and payments can be immediate or deferred. Annuities offer tax advantages and the guarantee of lifetime payments, but annual fees and surrender fees can be high.
Risk
Annuities, like any investment product, carry certain risks that could result in a loss of principal or lower-than-expected returns. Here are some key risks associated with annuities:
- Market Risk: Variable annuities are tied to investment portfolios, which means they are subject to market fluctuations. If the underlying investments perform poorly, the value of the annuity may decline, and the investor may experience a loss.
- Inflation Risk: Fixed annuities provide a guaranteed income stream, but the purchasing power of that income can erode over time due to inflation. If the rate of inflation exceeds the growth of the annuity income, the investor’s purchasing power may be diminished, resulting in a loss of real value.
- Interest Rate Risk: Fixed annuities are sensitive to changes in interest rates. If an individual purchases a fixed annuity when interest rates are high, they may receive a relatively lower return compared to prevailing rates if they were to purchase the annuity at a later time. Additionally, if an individual wants to exit the annuity before the end of the surrender period, they may face surrender charges.
- Longevity Risk: Annuities are often used to provide a steady stream of income throughout retirement. However, if an individual lives longer than expected, they may outlive the accumulated value of their annuity, potentially resulting in a loss of income in later years.
- Fees and Charges: Annuities often come with various fees and charges, including administrative fees, mortality and expense charges, investment management fees, and surrender charges. These costs can eat into the overall returns of the annuity, reducing the potential gains and potentially resulting in a loss for the investor.
- Default Risk: If the insurance company issuing the annuity becomes insolvent or unable to fulfill its obligations, there is a risk of loss. However, annuities are typically backed by state guarantee associations, which provide some level of protection to annuity holders.
It’s important for individuals considering annuities to carefully evaluate their financial goals, risk tolerance, and the specific terms and features of the annuity. Working with a financial advisor can help in assessing the risks, understanding the potential returns, and selecting an annuity that aligns with one’s investment objectives and risk tolerance.
The writer is an Economic Policy & Financial Analyst
