I Hate Annuities®
Annuities are often one of the most complex investments in the financial services industry. Yet, many investors purchase annuities for their alleged safety or “guaranteed lifetime income.” These features may appear attractive as a source for retirement income, but unfortunately, annuity guarantees often omit the potential disadvantages, such as high fees, withdrawal limits and strict requirements.
Our founder, Ken Fisher, is known for his less-than-flattering statements about annuities. Many annuity contracts are long, complex and confusing, such that even many insurance agents may not fully understand all the details. Before buying an annuity, it is helpful familiarize yourself with the basics of these complicated insurance products.
What Are Annuities?
Annuities are insurance contracts between you and an insurance company. You hand over a premium, either as a lump sum or in periodic payments. In return, the insurance company promises you a guaranteed income stream as a series of payments, or sometimes as a lump sum, at a specified time in the future. Annuity contracts are only as good as the insurance company behind them. If that firm goes bankrupt, your contract may be null and void.
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There are several different types of annuities, but the two basic types are deferred and immediate.
- Deferred annuities: You deposit a lump sum with an insurance company and let it grow tax deferred until a point in time defined in your contract.
- Immediate annuities: You deposit a lump sum for a guaranteed income stream, which you begin to receive after making your initial investments.
Within the deferred and immediate annuity categories, additional categories exist, such as fixed annuities and variable annuities.
Fixed annuities generally guarantee a certain interest rate. The payout is a fixed sum similar to a certificate of deposit (CD). The value of your principal will not fluctuate based on market movements, but the rate of return is generally lower than other annuities. Also, the interest rate can change at the end of a predetermined time frame, and in certain market conditions you may get a better rate from a CD.
In comparison, variable annuity premiums are invested in subaccounts, which generally resemble mutual funds. The payout depends on the performance of the underlying investments. When you compare annuities, you may find variable annuities have the highest potential return, but also the highest potential volatility and fees.
- You are generally taxed only on withdrawals.
- You may purchase optional enhanced benefits, called annuity riders.
- You may be able to pick the funds in which you invest.
- Your earnings, when withdrawn, are taxed as ordinary income instead of the, often lower, capital gains tax rates.
- Annuity fees can be substantial, potentially limiting your long-term returns.
- Annuity riders—or contract modifications—that limit your potential losses may also limit your gains. This feature can also really hinder your portfolio’s long-term return potential.
- Each subaccount or annuity rider may have additional fees.
Common Issues with Annuities
Conflicts of interest – When you hand over a significant amount of money to someone, trust should be your priority. One way to establish trust with an annuity provider is to understand their inherent conflicts of interest. Annuity providers often reward their salespeople with large commissions that are built into the policy. When those who are selling an annuity have a large incentive to sell a contract, it may be easy for them to ignore whether that product is the best fit for your personal situation and long-term financial goals. This situation could create a serious issue for you as a potential customer.
Misinterpretation of guaranteed returns – The adage “if it sounds too good to be true, it probably is” may apply to some annuities. Annuity salespeople can mislead investors by representing that they are purchasing something with a guaranteed return for life on a safe investment. However, the guarantee on an annuity isn’t a return on capital, but a return of capital until the contract ends. This generally means the annuity company may be just taking your money, giving it back to you in installments with a small premium, and then charging you for doing it. In reality, an income stream can often be set up without an annuity contract.
High fees – A major issue we find with many annuities is they rarely have a single flat fee. Instead, they often have multiple fees that could add up over time to several percentage points, detracting from your money’s long-term return potential. If you require long-term portfolio growth, these fees could cripple your chances of meeting your longer-term financial goals. Some common fees of variable annuities include:
- Annual administrative fees
- Annual mortality and expense risk fees
- Distribution fees
And, if you wish to add the guaranteed minimum death benefit or lifetime withdrawal benefit riders, you may face additional costs. These costs are usually small percentage points, but they can make a huge difference in the long run.
Unsure of any annuity features, annual fees or terminology in an annuity contract you are considering? Request your free copy of our educational guide Annuity Insights: Nine Questions Every Annuity Investor Should Ask today!
Asset lock-up periods – Annuities may require you to invest a premium and sometimes forfeit access to your funds for up to 10 years. But, during your retirement years you should expect to face many unknowns. Since you may not be able to tap into an annuity to cover unexpected expenses, you need to set aside enough of a nest egg in case of an emergency.
Excessive surrender charges – Variable annuities are expensive to exit or take withdrawals. They typically have a “surrender” period. For example, if you withdraw from a variable annuity before the surrender period ends, you could face substantial costs. These surrender charges may start at 7% of the annuity’s value and decline yearly over the surrender period.
Annuity income typically ignores inflation – Inflation may be one of the most overlooked factors when it comes to annuities. Consider a hypothetical annuity contract that offers an annual 5% return. This return on your account value may seem sufficient to cover your cost-of-living expenses. However, this rate doesn’t account for inflation, which can reduce your purchasing power over time. Though annuities’ annualized income may not increase along with inflation, some annuity contracts offer an inflation-adjustment feature. But, this feature usually comes with an added fee, which can also detract from your real return after inflation.
Annuity Evaluation Program
Have you overlooked any of the risks mentioned here that could be associated with your annuity? Are you looking for a second opinion that won’t lead to the sale of a “better” annuity? If you own annuities in a portfolio of $500,000 or more and would like more in-depth guidance, we encourage you to contact us for a free consultation.