What is an annuity? An annuity is a contract with an insurance company.
When you mention the word annuity, you’ll get all sorts of reactions. Many of those reactions will be negative and some will be positive. The positive reactions will generally be from folks that own an annuity and it’s doing exactly as needed. The negative reactions will come from people who were sold the wrong annuity, it didn’t accomplish what they needed, or they were sold one they didn’t need. There are also those that hate annuities and can’t say why. Then there are advisors and agents that love and only sell annuities… and those that won’t because it doesn’t fit into their business model. There is no one magic investment strategy to achieve your goals. Knowing whether an annuity is a good, bad or ugly option for your strategy is important.
There two categories of annuities out there and then there are different types and variations of annuities within those categories. The two type of annuities are Fixed and Variable.
These are annuities where you have no risk from losing your money in the stock market, you’ll get your initial investment back at the end of the term. For the most part, the insurance company is taking the risk. They are referred to as Immediate annuities, Index Annuities and MYGA (Multi Year Guaranteed Annuities).
Security: The Immediate and Index annuities may offer a guaranteed lifetime income option. Since the number one fear going into retirement is the fear of outliving your money, annuities with an income benefit attached can help by providing a lifetime income stream. Besides a pension and social security (which has been called the largest annuity in the world) only annuities can provide you with a lifetime income guarantee.
Fees: Most of the fixed annuities have either no fees or very reasonable fees.
Risk: Fixed annuities are safe because they will not risk your principal in the stock market. You will get your initial investment, the principle, back at the end of the term.
Surrender Terms: Some annuities have long surrender periods, and high surrender charges. The period is the number of years you commit your money to the insurance company and the surrender charge is the penalty you will pay if you take money out of your annuity early. There are exceptions. Almost all annuities will allow you to get to the money in case of death and some will allow you to get to it in the case of disability, terminal illness or if you are admitted to a skill nursing facility. Some annuities also will allow for a yearly withdrawal of a portion of your money without penalty, usually 5-10%/year. The term length varies depending on the annuity and company. I’ve seen some annuities have surrender charges for as long as 18 years. I would never suggest an annuity surrender period longer than ten years.
Returns: With the lower risk, comes potential lower returns. Although some index annuities have been designed to give you very reasonable participation in the indexes they track.
These types of annuities do fluctuate in the stock market. They can offer lifetime income riders and some offer death benefits.
Security: Again, these offer a lifetime income rider for a guaranteed income for life. Some annuities also offer death benefit riders for legacy planning.
Returns: With higher risk, comes the potential for higher returns. (You’ll see this again in the bad section.)
Surrender Terms: Same as above.
Risk and Performance: There is risk being invested in the stock market. The greater the risk, the greater the risk of loss. This is where you want to make sure you know what you want from your annuity. If is just an immediate lifetime income stream, then performance may not be as critical. If it is for growth or legacy, then be mindful of how the annuity is invested. There are variable annuities available that often lag in performance against specific indexes even though they are mostly invested in subaccounts that are essentially mutual funds. Most of the variable annuities available today are built on algorithms or they force you to own risk adjusted funds that are constantly moving your money back and forth between stocks and bonds. So instead of staying fully invested, your money is getting pulled in and out of the market based a computerized program.
Fees: These can get high as you add on benefits/riders.
Annuities are oversold and there are a lot of people that own an annuity today that probably don’t need. I’ve known advisors that put 90% of their customers in annuities because they find them easy to manage and explain plus they pay a higher commission. While the advisor may understand the product they sold, too often the client does not understand what they bought.
In Conclusion: I am not anti-annuity. I’m anti- the general public getting taken for a ride by an advisor giving bad advice and putting someone in a bad annuity.
Annuities are great when used for the right reason and when it addresses the customer needs and goals.
I’m an advocate for people to get the best possible investment advice and educated along the way. If you have an annuity but you have no idea how much in fees you are paying or what that annuity is doing for you, you probably need a second opinion on it.
In the end, not all annuities are created the same. Much like stocks and mutual funds, some are good, and some are not so good. Do your research and make sure an annuity is in line with your goals and objectives before you buy one.
Live free my friends
If you need a second opinion, I’m happy to help. Go to www.dialintoretirement.com/askericto learn more.