This Is Your Brain On Annuities



Annuity salespeople are literally hunting in the zoo. These complex products are often misused while clients are abused. This is not to say that some people would not benefit from a low-cost annuity as part of an asset allocation strategy.

The problem is the majority of the time the wrong people are targeted by commission-hungry salespeople posing as financial planners. Annuities are known for their mind-numbing complexities, which can make one’s head explode.

Here is a condensed primer on these products. After reading this, you should be able to determine if an annuity is right for you:

  • Annuities are insurance products and are not FDIC-insured.
  • They offer a death benefit so the sum of your premium payments will be paid as insurance against a market crash.
  • They provide income that cannot be outlived.
  • They generate tax-deferred growth with no limit on contributions if held in a taxable account.
  • They may be offered in a fixed, variable, or market-indexed structure.
  • They offer premiums that may be paid over time or in one lump sum.
  • The owner pays the premiums; the annuitant is the person whose life expectancy is used to calculate the annuity payments and who receives the payments.
  • The beneficiary will receive the death benefit if the contract owner dies before the payments begin.
  • These products can be useful for people who have a long life expectancy, have a genuine need to purchase income, and have maximized all tax-advantaged plans.  People who have complex business or estate issues that need individualized insurance attention are also candidates for certain annuity products.

The problem is most people who own annuities do not fit into these categories. They are often sold to people as the FIRST choice for tax-deferred growth. This is a blatant lie. In reality, annuities are third on the list.

According to Vanguard, clients can maximize their tax-advantaged retirement savings by:

  • First, contributing the maximum allowed under their work-sponsored plans;
  • Second, making any tax-deductible IRA contributions for which they qualify; and
  • Third, buying investments that grow tax-deferred, such as annuities.

Most people do not max out 401(k)s or 403(b)s or reach the stage where they fully fund tax-deductible IRA contributions.

Can someone please tell me why 70% of K-12 teachers have retirement dollars going into these products? It is a clear as day that these products should NEVER be the first choice for tax-deferral; especially for public service employees who have lifetime income, in the form of a pension.

In addition, many of these products have extremely high fees which are almost impossible to figure out. Annuities often come with 500-page prospectuses written by lawyers who are paid to protect insurance companies, not investors.

Often the insurance provided by these complicated products could be purchased in a much cheaper a la carte fashion. For instance, if you are worried about an unexpected death, your family would be much better protected by a cheap term life insurance product rather than the return of your premiums in a variable annuity.

Many of these products also come with high surrender fees which severely limit liquidity and encourage unsavory brokers to “churn” your account. This means they can collect upfront commissions every time you switch annuities while the new surrender charge clock starts from zero.

The S.E.C. provides an excellent set of questions to ask before purchasing an annuity:

  • Will you use the variable annuity primarily to save for retirement or a similar long-term goal?
  • Are you investing in the variable annuity through a retirement plan or IRA? Are you aware that will not receive any additional tax-deferral benefit from the variable annuity? (Note: Since qualified plans already contain tax advantages, the annuity’s tax-deferred growth provides no additional advantage.)
  • Are you willing to take a ride should the account value decrease if underlying investments perform badly?
  • Do you understand the features of the variable annuity? 
  • Do you understand all of the fees and expenses variable annuities charges?
  • Do you intend to be in the variable annuity long enough to avoid surrender charges if you withdraw money?
  • Are the features of the variable annuity, such as long-term care insurance,which you could purchase separately, cheaper?
  • Have you consulted with a tax adviser and considered all the tax consequences of purchasing an annuity, including the effect of annuity payments on your tax status in retirement?
  • If you are exchanging one annuity for another, do the benefits of the exchange outweigh the costs, such as any surrender charges you will have to pay if you withdraw your money before the end of the surrender charge period for the new annuity?

I am pretty certain the average annuity salesperson does not ask a potential victim, I mean client, “Have you fully maximized all tax-advantaged plans before saving somewhere else for retirement?”

Since about 50% of all retirement savers have exactly nada saved for retirement, it is not a surprise salespeople rarely make this inquiry.

While this is a brief overview, this post provides enough information for you to determine if you should own an annuity or not.

If you feel you have been sold a bill of goods, let us know. We would be happy to help.

I can promise you this: If you are not maxing out all of your tax-advantaged plans, annuities will not be part of a retirement saving discussion.

Unlike a lot of other people out there, we don’t think it’s fair to hunt in the zoo.