So I had a “financial advisor” from Hartford mutual back in my “younger days” (Dec2007) that sold me a Life Insurance policy and then proceeded to tell me the next thing I needed on my ordered list of investments was a deferred annuity. She said it was very stable and something I really should think about. At this time, I cut communication with her and haven’t asked for her “advice” in any recent investment scenarios because of it. Why don’t I? Because you really have to be SOLD an annuity, you don’t INVEST in it…
The main reason that it’s so easy to sell this product is that it is so complicated to understand. The ins and outs of them are very intricate and can move your money around pretty uniquely keeping you in the dark about them, while sliding your $ into the sellers pocket. If you’re going to get into one, I’d strongly consider other alternatives first off in your investment path and be sure they’re COMPLETELY maxed out before digging into the annuity world (and even then I may invest in bugs or moon real-estate before it).
What exactly IS an annuity?
An annuity is sold to you by an insurance agent. The point of it is that you make a lump sum payment or series of payments, and the money grows tax-deferred at a fixed or variable rate. This is the rate they set, and can be changed, for the most part, at any point usually at your expense. In return for them housing your money in this poor investment, the insurer agrees to make periodic payments to you for the rest of your life after they been using your money as a loan to themselves for the previous 20 years or whatever timeframe you’ve had it for.
A deferred annuity can encompass any of the following more confusing forms:
In a variable annuity your cash is invested much the same way as mutual funds. You can see it sometimes with a ticker symbol if you can coax the seller to give it to you, or you can just let them manage it for you with “your best interests at heart” I’m sure. Furthermore, on death, you will be passing the tax on the earnings down to your heirs that you had built up during your lifetime. Outside an annuity, the part of the inheritance attributable to unrealized capital gains would be tax-free.
This is like a fixed mortgage. The payout is locked in at a guaranteed rate of return for periods ranging from one year to ten years. Rates can fluctuate but will never drop below your guaranteed rate. You won’t lose money, but you won’t have the potential for growth you’d get by investing in things outside of their realm like real-estate or stocks. It may make sense if you’ve tapped all your prior resources for $ and meet the annuity-buyer profile and have low risk tolerance.
Much like an equity mutual fund, you get a guaranteed rate and fixed payments with this product. But unlike the fixed rate, this one is tied to a standard index fund like the S&P500.
So these don’t sound all that bad if I’m looking to retire soon, right?
Well, maybe, but let’s look at fees you’re paying:
- Variable annuities have a mortality and expense charge just like an insurance policy does.
- Administrative and annual records maintenance fees are deducted from the “investment”.
- Annual fees, like in mutual funds are about 2%.
- There is also the Surrender fee that will apply if you withdraw early which are usually around 5.5%.
- And don’t forget the yearly contract charge of $25.
Is it for me? Is it for ANYONE?
Well, like I said above, I wouldn’t even think about buying one ever because I think there are better options out there. But if I was to give recommendations to others I would tell them not to buy unless they were contributing the maximum to other retirement plans, and considered all of the other investments on their list first.
Taxwise you’re not getting a deal either because if you invest in an annuity inside a tax-advantaged account, you get no extra tax benefit.
The person I may possibly recommend it to would have to fit a very specific profile though with these characteristics:
- They have maxed out their order of investment list.
- They don’t need short term income for at least 15 years.
- They can live without this money until at least 59 1/2 (when you can withdraw it without paying early withdrawl fees).
- They are in at least a 25% tax bracket (to take advantage of the tax deferral).
- They are concerned they may outlive their savings.
Keep aware of these “investments” when your “advisor” recommends them to you and you don’t fit in the specific pie above as they may be trying to sell you something you have absolutely no need for. If they DO push it on you, I suggest it time to find a new advisor.