Annuities: The Good. The Bad. The Ugly.

Subtopic: Malbec Air Date: July 31st, 2020

An annuity is a contract between you and a life insurance company that promises a stream of income for your lifetime in exchange for a lump sum premium or a series of premiums paid to the insurer. The income is either paid in installments at the beginning of the contract (immediate) or in the future (deferred).

They are popular with retirees but sold to a wide variety of consumers. You’ve heard all the opinions spanning both sides of the spectrum on these contracts. There’s advantages, but like many investments it is not a one size fits all.

The main thing to take away from this is before you agree to tie your money up in an annuity contract, fully understand how they work and the affects they can have on your plan.

What are the two basic types of annuities?

  1. Fixed – fixed rate of return from the insurance company for a specific period based – the rate is going to be based on projections of the current investments and market conditions – most are going to include a guaranteed minimum
    • Index Annuities (equity indexes annuities)
  2. Variable – places the risks and rewards on the annuity holder. The holders determines how the account is to be invested by selecting from a group of portfolio types ranging from very conservative (MM, bonds fixed income) to your more aggressive all equity type strategies. These are all based on return – it would be prudent to analyze historical returns of the separate accounts the same way you would a mutual fund

Digging further into annuities.

These are some of the types of contracts and nuances the contracts can have:

  1. Immediate vs deferred
  2. Qualified vs Non-qualified
  3. Irrevocable consequences
  4. Delayed access – 10% excise tax prior to 59 ½
  5. Taxes – withdrawals from non-qualified annuities are treated as ordinary income rather than capital gains. Depending on your tax situation, rates could be higher than the current cap gains rate. Death benefits can also become taxable
  6. Surrender charges – can be as high as 22% in year one typically declining based on a scale
  7. Commissions – most range from 2-7% or more. The agents reap large rewards and may be incentivized to sell you these contracts based on their own income needs rather than how it fits into your plan (Financial Abuse of Seniors – being misled)
  8. Annual fees – admin, mortality expenses – many layers of fees that can eat into the performance

Is an annuity right for you?

Sales have been growing significantly for several years- there’s many benefits and features, the problem is that your average investor isn’t aware of the trade-offs

What are the Perks?

  1. Tax deferral – just like 401(k) and IRA, your contributions/earnings can grow tax-deferred until your withdrawal.
  2. Income for life – “private pension” – periodic payments can bring a reliable source of income in retirement
  3. Death benefit – they provide a standard death benefit: premiums minus withdrawals
  4. Payments to a beneficiary

One thing to consider is time horizon – typically annuities are not short term investments and can tie your money up for an extended period of time – surrender charges spanning 10 years.

Always talk to your advisor! While it’s true they can carry some significant fees, and be a bit complicated, annuities can be a great tool. They can fill a void and allow investors to remove risk from their total investment strategy. Annuities eliminate the ability for investors to make moves based on emotions. They can actually relieve some stress as well as an investor knowing that your money is tied up and you do not have to try and time changes.