Come Watch The Unraveling Of The Annuity’s Mysteries
March 17, 2017 by Marie Beerens
Annuities have gotten a bad rap among many people and for a reason. Often, insurance agents and others are willing to sell annuities to just about anyone, whether the person needs it or not. The driving factor is often the high commissions they’ll get from selling the product.
So, let’s debunk some of the common misconceptions about annuities and look at the benefits and risks those instruments really carry.
In its simplest form, an annuity is a contract to pay out a fixed sum of money for a set period of time or until death. There are four main types: immediate, deferred, fixed and variable. But there are many variations, and that’s where people get confused.
In immediate annuities, a lump sum of money is paid and in return a fixed sum is paid out starting right away. In deferred annuities, money is paid in, and the payouts start at a later date.
“Annuities are often sold for the wrong reasons,” said Jill Schlesinger, CFP, senior CFP Board Ambassador and business analyst for CBS News. “The thought process behind an annuity was: How can we help people get a stream of income throughout their retirement so they don’t feel like they’re going to blow through their nest eggs.”
With the proliferation of many different types of annuities, the cost of getting one has also gone up. Often, extra fees for additional riders and features are hidden within the fine print of the more complex contracts. It takes an expert to really understand and be able to explain what features, and therefore fees, are necessary for achieving your financial goal.
“The best annuity is the one that contractually solves for your specific situation,” said Stan “Stan The Annuity Man” Haithcock, top independent annuity agent in America. “If your goal is to get pension-type income now, I need it to start immediately, and I need to get for the rest of my life the highest contractual payout I can find, then that type of annuity is called a single-premium immediate annuity.”
Haithcock explains that it really comes down to two questions: “What do you want the money to contractually do and when do you want those contractual guarantees to start.”
Some of the most popular annuities are variable and index annuities. Haithcock points out that over 70% of all annuities sold in the country every year, or the equivalent of over $300 billion, are of those two types. But, “That doesn’t mean they’re the best, that doesn’t mean they’re the ones you need to buy. That just means they have the highest commissions, period.”
So what’s a potential investor to do?
The first step is to shop around, and don’t hesitate to get a second or third opinion. Haithcock says they’re commodity products that need to be shopped through all carriers for the best contractual guarantees. “You never buy hypotheticals or theoreticals or projected return scenarios, but that’s how variable annuities and index annuities are sold … . You own an annuity for what it ‘will’ do, not what it ‘might’ do.”
Another component is that you don’t want to buy an annuity when you have a better, cheaper option available, points out Schlesinger. An example would be putting a young person into an annuity where in reality, he or she could be saving for retirement by maxing out their 401 (k) plan and employer contributions. In addition, locking in the money into an annuity at a very young age puts the person in danger of being stuck in illiquidity when there is a need to use the funds to buy a first home or for college expenses of the kids.
Dan Keady, CFP, CFP Board Ambassador and senior director of financial advice and planning at TIAA, says that the most popular annuity at TIAA is the fixed annuity. “It’s really very simple and it’s the original one. One of the core points that makes it very popular is the certainty behind it.”
A fixed deferred annuity accrues interest tax-deferred at a guaranteed rate. In addition, “Many people are wondering how long will I live in retirement and the nice thing about this kind of annuity is that at your option, you have the right to convert it into an income stream that you can never outlive,” he said.
The problem with other types of annuities is that they can get very costly due to the additional features and riders. “It’s very important to understand if that particular benefit, or rider as they would call it, is of value in their specific situation,” said Keady.
Schlesinger believes there are two times when annuities are interesting: 1) when someone comes into a lump sum of money, such as an inheritance, and wants to earn income without having to put someone else in charge of the sum; and 2) when taking a portion of your total net worth and securing guaranteed payments for life.
“There are some lower-cost alternatives that a lot of fee-only advisors are starting to use more and more,” said Schlesinger. That’s why it’s important to work with a financial advisor that is held to the fiduciary standard to explain all the choices available. “You may decide you’d rather pay 2% a year for peace of mind than 1% a year with some more risk, but you’ve got to understand what that choice is.”
