A Skeptics View of Annuities
If I had 10 annuities across my desk, based on my standards alone I would throw away eight of them. In my opinion, many of these annuities do not stack up against other annuities or other investment vehicles. My belief is that no financial advisor should convince you to hate or love any investment. Every investment has a purpose for a select group of investors. What you have to determine is, does it match your needs? Your needs are unique, so this simple guide can serve as the beginning of your exploration.
How do they work? Fixed annuities are similar to CDs, but they are insurance contracts offered by an insurance company. You agree to purchase the contract from the insurance company and they in return agree to give you a stated percentage of your premium every year. They typically have 3, 5, 7 and 10-year arrangements. While fixed annuities may require extra education to fully understand how they work, they tend to have higher interest rates than CDs.
Are there any fees? Typically, no. It is a relatively straightforward investment vehicle in which you are separated from your capital for a period of time and they pay you guaranteed interest. The insurance company will invest your money on deposit and earn its fee by trying to earn a higher spread on your money while paying you a fixed interest rate. However, be sure you do ask about any additional riders. Riders offer additional features, but those benefits come at a cost.
How liquid are my funds? Not very liquid, because you are trading the use of your money for a specific return. Some fixed annuities allow for 10% penalty-free withdrawals, which is unique compared to CDs at a bank.
Is it protected? Yes, fixed annuities are backed by the financial strength of the issuing insurance company. You should do your due diligence to see how the insurance company is rated by a rating agency – which assigns a grade based on its financial stability. The insurance company’s financial stability is your first line of defense. Beyond that, each state has a program similar to the Federal government’s FDIC. Each insurance company licensed to operate in that state pays into the state insurance fund to provide relief to insurers that run into financial troubles during tough economic times.
The Pros and Cons of a Fixed Annuity
- + Guaranteed interest (guaranteed by the insurance company)
- + Easy to understand terms
- + Your principal is safe
- – Your return will be low in comparison to inflation
How do they work? A variable annuity is a contract with an insurance company that utilizes subaccounts (which work like mutual funds) to grow your account value. How much will you earn? It depends on the funds you have chosen and their subsequent performance. Now, be careful; I have had many clients buy a variable annuity who were under the impression that they would make a guaranteed 6, 7 or even a 10% return. I had to explain to them the full story – that those guarantees were only based on their income rider. What is an income rider? It is additional value separate from your account value that grows at a predetermined rate. Variable annuities can be complicated because you have to track an account value and an income value. The income value is not a value you can cash out and run to the Bahamas with. Often there is a percentage every year you can take out; let’s say 5% a year off the income value, and the issuer automatically sends that to you every year for the rest of your life. It is a monthly, quarterly or annual income that you cannot outlive.
Are there any fees? Yes, be cautious and take your time to inventory and understand all of the potential fees in a variable annuity. These may include (but are not limited to) a mortality expense fee, subaccount fee, administration fee, income rider fee, and death benefit rider fee. In my career, I have seen variable annuity fees as low as 1.2% and as high as 4.3% per year. Do your research and do not feel awkward about getting a second opinion for any annuity you are considering.
How liquid are my funds? Not very liquid. Many variable annuities will offer a penalty-free withdrawal amount. Typically it is as much as 10%, penalty free, every year. If you don’t use the penalty-free withdrawal, it may reset on the anniversary year. Your penalty-free withdrawal rarely accumulates.
Is it protected? – The key word is ‘variable’ with the variable annuity. Your account value will go up and down based on the market performance of the underlying subaccounts. Now, if you select an income rider or a death benefit rider, then those values may receive some degree of protection from market loss.
The Pros and Cons of A Variable Annuity
- + Higher growth potential than a fixed annuity, depending on investment subaccounts selected
- + Can be an appropriate investment for creating guaranteed income
- – Complex to understand and to track
- – Your account values are not guaranteed
- – Fees may be very high
Fixed Indexed Annuity
How do they work? Fixed indexed annuities (FIA) can be explained as a hybrid between a Fixed Annuity and Variable Annuity. The fixed index annuity’s principal is protected, but your interest is not guaranteed and is instead based on the index options associated with the contract. Fixed indexed annuities offer the opportunity for a higher income payout because your accumulation potential is based on indexes that track various markets, like stocks, bonds and commodities. With an FIA, there are not two income and account values to track, but one account value that will rise or remain flat based on investment gains of the linked market index. They typically offer 3, 5, 7 and 10-year arrangements.
Are there any fees? Typically no, but it does depend on the choices you select. Many FIAs do not have any fees unless you add a rider. The insurance company will invest your funds separately and make a profit off of your principal while it is on deposit with them, similar to how a CD has no fees. Be cautious and make sure you ask if there are any fees or if there will be any rider fees associated with your purchase.
How liquid are my funds? Not very liquid. The downside of annuities is that they work off your lack of need for liquidity for this portion of your portfolio. Remember, liquidity either makes you money or loses you money. Be sure to plan ahead for any future financial events in which you will need access to funds, and allocate another account in your portfolio for these needs. FIAs typically allow for 10% penalty-free withdrawals, and these withdrawals rarely accumulate. Lastly, they come in 3, 5, 7 and 10-year versions.
Is it protected? Yes, your principal is protected, but please do your research on the insurance company you are considering. The insurance company’s rating is public information. Your first layer of protection is the financial solvency of the insurance company where you purchase the contract. The insurance industry and many current companies have a long history of surviving through hard economic times such as recessions, world wars and the Great Depression.
The Pros and Cons of a Fixed Indexed Annuity
- + Your principal is safe
- + Easier to understand than variable annuities
- + Your return may not be as high as a variable annuity
- – Your funds will be tied up for a period of time that you predetermine at the time of purchase
Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM) and/or Swan Capital. AEWM and Swan Capital are not affiliated companies. All investments are subject to risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Any references to guarantees or lifetime income generally refer to fixed insurance products, never securities or investment products. Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. This content is provided for informational purposes only and is not intended to serve as the basis for financial decisions.
Annuities are insurance products that may be subject to restrictions, surrender charges, holding periods, or early withdrawal fees which vary by carrier. Riders are generally optional and have an additional associated cost. Annuities are not bank or FDIC insured. Liquidity is generally in the form of policy loans and withdrawals. Policy loans are subject to interest charges. Adverse tax consequences may result if withdrawals exceed premiums paid into the policy. Withdrawals or surrenders made during a surrender charge period will be subject to surrender charges and may reduce the ultimate death benefit and cash value. Long term care (LTC) riders are not available on all index universal life products and may not be available in all states. Addition of the LTC rider may require an additional fee and LTC riders are subject to eligibility requirements. Income riders are generally optional and have an additional associated cost. 00627560