The debate around annuities and if they are a good investment choice has been going strong for years and doesn't seem like it will cease anytime soon. But instead of rehashing the usual arguments, let's look at it from a different perspective.
If you are currentlyplanningfor retirement and are looking for the right financial instrument to achieve the best growth and income results, you are better off using a dividend stock investing approach rather than use annuities.
Dividend Growth Prospects
When you set up an annuity, the upside on your portfolio becomes very limited. Depending on what type of annuity you choose, you have either no growth on an immediate annuity or minimal growth due to fees on other types of annuities. With a dividend stock portfolio, not only do you get income from the dividend, but you get the capital gains from the stocks' price growth.
The downside of growth with dividend stocks is that you will take on more volatilitybecause there is no guarantee. As long as you are not selling your stock when the market goes down and are only living off of the dividends, this isn't a big issue.
On the other hand, if this factor would keep you up at night, guarantees that come with annuities may be worth the growth trade-off for you. Just remember that annuities are an insurance policy, so they're only as good as the company you buy them from. If the firm goes out of business, you're out the money.
Taxes Stack-Up
When looking at taxes, there are two major differences between the two options. The first is how your earnings are taxed; the second is the cost basis for your heirs if you pass on the asset to them after death.
With the taxes that you pay on your earnings in an annuity, you are taxed at your ordinary-income rate. However, with dividend stocks, you pay a lower rate on the qualified dividends—and if you are in the lowest two tax brackets, you don't pay any taxes. Additionally, if you sell your stock for a gain, the capital gains tax tops out at 20% for the highest tax bracket. This can make a big difference in the taxes you pay during retirement.
When you pass on assets to your estate, there are different rules for what your heirs' cost basis becomes. With an annuity, they get the same basis that you had. With stocks, they get what is called step-up basis—this means that their cost basis is what the price of the stock was of the asset on the day you died. This can make a major difference in how much they eventually get taxed even if you had a 100% gain on the stock. If they sold it for the new basis, they would owe no capital gains tax.
How the Fees Add Up
Fees can destroy the growth potential of a portfolio. They make it harder to reach your goals because you have to not only make the return you need to achieve your goals, but you have to also make back the fees that you pay for the investment.
Having a dividend stock portfolio is one of the cheapest ways to own an asset. You pay a transaction fee to purchase the shares and then don't have to pay any other fees until you sell the stock. At most brokerages, you can even reinvest the dividends at no additional cost. If you structure your investments so that you eventually live off the dividends and don't sell the stock, then you only pay one fee.
Annuities, on the other hand, are full of fees. Not only do you have large commissions up front, but you are also subject to surrender charges if you want to get out of the contract, fund expense chargesand many more.
The Bottom Line
Annuities are an expensive way to prepare for retirement. Using dividend stocks will see a minimization in fees and taxes, and you still get the growth and income that you'll need for your non-working years.
FAQs
Fixed annuities are a fantastic way to build out the more conservative side of your portfolio. Dividend-paying stocks can be a good choice for the more moderate and high-risk side. Fixed annuities provide stability and certainty, whereas stocks can be volitile with a potential for large earnings.
Are dividend stocks better than annuities? ›
Annuities are an expensive way to prepare for retirement. Using dividend stocks will see a minimization in fees and taxes, and you still get the growth and income that you'll need for your non-working years.
What are the disadvantages of dividend stocks? ›
Despite their storied histories, they cut their dividends. 9 In other words, dividends are not guaranteed and are subject to macroeconomic and company-specific risks. Another downside to dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders.
Are dividend stocks a good retirement strategy? ›
Benefits Of Dividend Investing
Cash income: Dividend stocks provide periodic cash income, which improves your liquidity and financial flexibility. Appreciation potential: Dividend stocks gain value over time. Relative to stocks that don't pay dividends, the appreciation gains are usually lower.
Is investing in dividend stocks a good idea? ›
Dividend investing can be a great investment strategy. Dividend stocks have historically outperformed the S&P 500 with less volatility. That's because dividend stocks provide two sources of return: regular income from dividend payments and capital appreciation of the stock price.
Are annuities safe if stock market crashes? ›
So, the answer is yes, it's a Fixed Annuity. It's not a security, a market-type product, or a market return product, regardless of what you hear out there. Fixed Index Annuities are CD-type products with normal CD returns. They do protect your principal if you attach an Income Rider to it.
Do the rich invest in annuities? ›
The Bottom Line
Wealthy investors can leverage certain aspects of annuities, which is one of the reasons they are popular. For example, those with a high level of disposable income can contribute to an annuity if they have maxed out their traditional retirement plans.
What is the dividend trap? ›
A dividend trap is where the stock's dividend and price decrease over time due to high payout ratios, high levels of debt, or the difference between profits and cash. These situations commonly produce an unsupported but attractive yield.
Can you live off dividends in retirement? ›
Depending on how much money you have in those stocks or funds, their growth over time, and how much you reinvest your dividends, you could be generating enough money to live off of each year, without having any other retirement plan.
What is the problem with dividend stocks? ›
Dividend stocks are vulnerable to rising interest rates. As rates rise, dividends become less attractive compared to the risk-free rate of return offered by government securities.
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
How to make $500 a month in dividends? ›
That usually comes in quarterly, semi-annual or annual payments. Shares of public companies that split profits with shareholders by paying cash dividends yield between 2% and 6% a year. With that in mind, putting $250,000 into low-yielding dividend stocks or $83,333 into high-yielding shares will get your $500 a month.
Do dividends reduce Social Security? ›
Pension payments, annuities, and the interest or dividends from your savings and investments are not earnings for Social Security purposes.
Should I focus on dividends or growth? ›
If you are looking to create wealth and have a longer time horizon, staying invested in growth will enable you to enjoy longer returns. But if you are looking for a more immediate return and steady cash flow, dividend investing could be the best choice for you.
What is the best dividend stock to buy right now? ›
Let's explore five stocks that are proven, reliable dividend payers and assess why now looks like a good time scoop up shares in each.
- Hercules Capital: 9.9% dividend yield. ...
- Horizon Technology: 11.4% dividend yield. ...
- Ares Capital: 8.9% dividend yield. ...
- Altria: 8.5% dividend yield.
Top 25 High Dividend Stocks
| Ticker | Name | Dividend Safety |
|---|
| VZ | Verizon | Safe |
| WPC | W. P. Carey | Safe |
| CCI | Crown Castle | Borderline Safe |
| T | AT&T | Borderline Safe |
6 more rowsMay 10, 2024
There are a variety of options that are better than an annuity for retirement, depending on your financial situation and goals. These include deferred compensation plans, such as a 401(k), IRAs, dividend-paying stocks, variable life insurance, and retirement income funds.
Should I buy an annuity or invest in stocks? ›
Both could be appropriate for your portfolio, but they fulfill different functions. Fixed annuities are a fantastic way to build out the more conservative side of your portfolio. Dividend-paying stocks can be a good choice for the more moderate and high-risk side.
What is a disadvantage of annuity investing? ›
Annuities can lose value, especially variable annuities, where returns are tied to investment performance, so poor-performing investments can lead to a lower account value. Indexed annuities may return less than expected due to costs like caps and fees.
Should I move stocks to an annuity? ›
As you near retirement, it is wise to shift a significant portion of your savings from stocks to principal-guaranteed products like CDs and fixed annuities. This helps to ensure that your retirement plans remain on track, even if there is a market downturn.
