People miss out on proven solutions to retirement saving and planning because they swallow myths and misconceptions
I HATE Annuities! screams the headline. The ad goes on to list what Ken Fisher, a famous money-manager, claims are the sins of annuities.
Those ads have an impact. Many of our callers say they've heard that annuities are bad. And no doubt many others don’t call at all because they’re convinced annuities are rip-offs.
Fisher’s ads are misleading because they’re a gross oversimplification. His beef is primarily with just one type of annuity, the variable annuity. Even he admits fixed annuities can be okay.
Like any financial instrument, annuities have pros and cons. Some types aren’t right for some people, just as some mutual funds or other investments are unsuitable for some people.
But some annuities are a perfect solution for some people because they do things no other financial product can. Fixed annuities are tax-deferred and guaranteed by the insurer. And only annuities can provide guaranteed income for life.
The oversimplifications and myths about annuities are spread by people selling competing products. The critics lump all annuities together, but different types are quite different. A standard fixed-rate annuity acts much like a tax-deferred version of a bank certificate of deposit. In contrast, a variable annuity can be invested in volatile, high-growth funds.
Here are the top annuity myths and oversimplifications.
Annuities have high fees. Fixed annuities have no consumer fees unless optional riders are added. With fixed annuities, which guarantee return of principal, 100 percent of the money deposited goes to work immediately.
Variable annuities do have ongoing fees, but you can shop to avoid the pricier offerings.
The simplest type of fixed annuity is the multi-year guaranteed annuity. It’s often called a CD-type annuity because it works much like a certificate of deposit. Like a CD, it offers a set rate of interest for a certain period of time, but the annuity is tax-deferred. Interest rates usually beat those of CDs with the same term.
There are no fees (absent the addition of optional riders) on other types of fixed annuities: immediate annuities, deferred income annuities (longevity annuities), and fixed indexed annuities.
Insurers don’t need to charge fees on fixed-rate annuities because the sales commission to the agent is modest.
Variable annuities, in contrast, which offer investors growth potential, do have ongoing fees. Ongoing fees are deducted from investment earnings, just as mutual funds charge investment management fees. Additionally, there is a mortality fee.
Fisher makes it sound like all annuities are variable annuities, but nothing could be further from the truth. His ads should be titled ‘I Hate Variable Annuities.’
Investors can avoid fee-heavy variable annuities by comparing fees before buying. Keep your eyes open and ask questions.
If you own a variable annuity with high fees, you may be able to swap it for a more cost-effective product via a tax-free 1035 exchange.
Annuities are bad because you’ll get hit with a charge if you surrender them early. Most annuities have surrender periods and early withdrawal will result in a penalty. But that fact doesn’t detract from the value of annuities.
It’s just something people need to be aware of. CDs too have penalties for early termination.
If you don’t cancel an annuity before the term is up, you won’t be hit with an early surrender charge. An annuity is meant for money you won’t need for a while.
If you’re concerned about the length of the surrender period, look for an annuity with a shorter period.
What if you unexpectedly need your money during the surrender period?
You have a couple of options. First, you can take a partial withdrawal, typically up to 10 percent of the accumulation value each year, without penalty. (The withdrawal of earnings counts as taxable income.) Second, you can usually annuitize the contract—turn it into a stream of income—without penalty.
Annuities provide lower returns than stock mutual funds or ETFs. Fixed annuities have neither the full growth potential of stock funds nor the downside risk either.
They’re all about safety and giving you a reasonable guaranteed return.
CDs and bonds are a more appropriate yardstick, and fixed annuities compare very well. CD-type annuities usually pay more than bank CDs with the same term, sometimes substantially more. Fixed annuity returns often compare favorably with returns of bonds and bond funds. The share price of bond funds varies, so the investor is not guaranteed to get principal back.
The variable annuity is the one type that does offer growth potential that can keep pace with mutual funds. But along with that comes downside risk that varies with the investment funds you choose.
Annuities pay high commissions that incentivize agents to steer buyers into bad deals. Most annuities pay agents quite modest commissions. CD-type annuities and immediate annuities in particular pay in the range of 1 percent to 3 percent. Deferred income annuities (longevity annuities) pay the agent around 2 percent to 4 percent.
The commissions are built into the product structure so that the buyer doesn’t pay a direct fee.
More complex fixed-indexed and variable annuities do pay somewhat higher commissions. That doesn’t make them bad deals. However, you do need to compare these types of annuities carefully to make sure you’re getting a fair deal.
Annuity expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities.
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