Annuities are not a new concept. They’ve been around for a long time, and many individuals have bought into them. They promise income for life. And who wouldn’t want income for life? As traditional sources of guaranteed retirement fade — like pensions, many people are doing whatever they can to ensure they have supplemental income during their retirement years. And at first glance, annuities seem to be a smart way to go.
An annuity is a contractual agreement between an insurer and an investor that states that when the investor makes an upfront lumpsum payment (or buys into an annuity) to the insurer, the insurer will, in turn, guarantee the investor future payments at regular intervals. Depending on the type of annuity the investor purchase, they may even receive income for life. There are two types of annuities: immediate and deferred, and the returns can be from a variable annuity, indexed annuity or a fixed annuity.
If an annuity sounds too good to be true, it usually is. Here are five reasons why investors should avoid annuities.
#1. High Commissions for the Seller
Even though the insurer should always have the best interest of the client at heart, sometimes the investor can be persuaded into buying into an annuity versus another type of investment, like mutual funds. This is because the seller will receive a commission from the sale of an annuity. While fiduciary responsibilities should always be in play, it’s not recommended to do this type of business with any company you know very little about. Integrity is key when it comes to an investment of this magnitude. So buyer beware; not all insurers are looking out for your best interest.
#2. High Fees
While you may not see upfront charges from the purchase of an annuity, they’re there and they can add up quickly. Annuities carry annual maintenance and operational charges, that again, can be more expensive than mutual funds. So again, buyer beware! If you don’t read the fine print on your contract, you may not learn about these additional fees until later on when you’re trying to determine what happened to some of your money.
#3. Withdrawal Charges
Additional charges (surrender charges) apply to an investor if they take money out of this account before a certain period, even if you have a financial emergency. Most annuities cannot be touched before seven to ten years. If money is taken out before this period, there is a surrender fee the investor will have to pay. Although surrender charges tend to decrease the longer you have the annuity, there is still a price to pay for withdrawing your money earlier than agreed upon in the contract. In addition, if the annuity owner is under a certain age (59 ½), they will have to pay a 10 percent penalty on any monies taken out of the account. This is information that should be known upfront, but depending on who you’re doing business with, I encourage you to read all fine print carefully.
#4. Returns May Not Match the Market
Don’t assume that your investment will match those of an equity index. Just because a specific index did well during a particular year does not mean that you will receive a return that matches that. Some insurance companies set you up to receive a little as possible with a clause called, a participation rate. This means your return is capped so that your investment can only grow by a certain amount, say 80 percent. This means you lose out on what others are receiving through other modes of investing.
#5. Stuck in an Immediate Contract
An immediate annuity can be tricky in that once you buy it, you’re stuck with it. Let’s say you have a change of heart and decide you want to pass your payments on to a beneficiary. You’re not able to make any changes to this type of annuity. Most contracts do however allow for a cash-refund feature in which your heirs will recoup the premium paid for the annuity. You can also set these contracts up as single life or joint lives. With the joint income option, your spouse will receive income payments for the rest of their life.
The bottom line is to make sure you always understand the fine print of anything when it comes to your financial planning. Retirement is a big deal, and the last thing you want to do is outlive your income. While annuities may seem like a smart way to not run out, you want to make sure you understand every detail of how they work. Most importantly, you want to ensure you’re dealing with a company that will always have your best interest at heart and will stand on integrity.
At JDH Wealth Management, we take the time to get to know our clients. We build relationships with our clients to know what they need based on where they’re trying to go. We also educate our clients on everything they need to know to make well-informed financial decisions.
If you ever have any questions surrounding annuities or investing in general, please reach out and we’ll help you with your retirement and investment needs.
Written by Matthew Delaney