Can You Lose Money in an Annuity?

Annuities are contracts between an individual and an insurance company, primarily designed to provide a steady income stream during retirement. These financial products appeal to many seeking guaranteed income and tax-deferred growth for their savings. While annuities offer benefits, it is important to understand scenarios where their value may decrease.

Understanding Annuity Types and Their Risk Profiles

Different annuity types expose investors to various forms of reduced value or not achieving anticipated returns. Each type carries distinct risks that can affect the financial outcome.

Variable annuities link their value to underlying investment sub-accounts, which can include stocks, bonds, and money market funds. Because these sub-accounts are subject to market fluctuations, the annuity’s account value can decrease if the market performs poorly, potentially leading to a loss of principal. While certain riders can mitigate some market risk, these protective features typically come with additional costs, further impacting the net return.

Fixed annuities generally guarantee the principal investment and offer a fixed rate of return for a specified period. However, the primary concern with these annuities often relates to inflation risk. Over time, persistent inflation can erode the purchasing power of fixed payouts, meaning the money received in the future buys less than it would today. This erosion of purchasing power can feel like a loss in real value, even if the nominal principal remains intact.

Fixed indexed annuities (FIAs) offer a degree of principal protection from market downturns. Despite this protection, a “loss” can occur through the potential for zero gains in flat or declining markets, or significantly capped gains in rising markets. This limitation arises from mechanisms such as participation rates, caps, and spread fees, which restrict the amount of market index growth that is credited to the annuity. Consequently, the annuity may not keep pace with overall market growth or inflation, representing a missed opportunity for higher returns.

Costs and Penalties that Reduce Your Value

Beyond the inherent risks of different annuity structures, direct charges and penalties can significantly reduce an annuity’s value. These costs are common across many annuity products.

Surrender charges are fees imposed if money is withdrawn from the annuity before a specified period, known as the surrender period, ends. These periods typically range from three to ten years, with six to eight years being common. The charges often start high, for instance, between 6% and 10% of the withdrawn amount in the first year, and then gradually decrease over the surrender period. Early withdrawals can substantially reduce the principal amount an individual receives.

Administrative fees are annual charges for managing the annuity contract, covering record-keeping and processing transactions. These fees are often calculated as a percentage of the annuity’s value, typically ranging from 0.10% to 0.50% annually, or they can be a flat fee, such as $50 to $100 per year. These ongoing costs directly reduce the overall value of the annuity over time.

Mortality and expense (M&E) fees are commonly found in variable annuities. These charges compensate the insurance company for the insurance risks it assumes, such as guaranteed death benefits or lifetime income. M&E fees are typically assessed as an annual percentage of the contract value, often ranging from 0.5% to 2%, with 1% to 1.5% being common.

Rider fees are additional costs for optional benefits or guarantees added to the annuity contract. These riders can include features like guaranteed minimum withdrawal benefits, guaranteed lifetime income benefits, or enhanced death benefits. The cost of these optional benefits can vary, typically ranging from 0.25% to 1.5% of the contract value annually, and these fees reduce the overall account value or potential return.

Other Factors Affecting Annuity Value

Several other factors can also diminish an annuity’s effective value or utility over time. These elements are external to direct contract fees but are important considerations.

While uncommon, there is a theoretical risk related to the financial health of the issuing insurance company. If an insurance company were to become insolvent, state guarantee associations are in place to protect policyholders. These associations provide a safety net, typically covering annuity benefits up to $250,000 per annuitant, though specific limits can vary by state. Any amount exceeding these limits might not be fully recovered, potentially resulting in a loss for the annuitant.

Annuity withdrawals also have tax implications that can reduce the net amount received. While earnings within an annuity grow tax-deferred, withdrawals are taxed as ordinary income when taken. Furthermore, if withdrawals are made before age 59½, the taxable portion may be subject to an additional 10% IRS penalty, in addition to regular income taxes. This penalty reduces the effective return on the investment, impacting the overall financial benefit.