Response: I recently wrote a response to a question that someone posed to me with regards to getting a second opinion on their annuity, to which I responded that it's always a good idea to get a second opinion about anything if you feel you are having a lopsided conversation. Meaning, if you are getting all the good, but feel as though the negative aspects are being left out... you might want to take some more time before making a decision. One blog reader posted a comment that essentially said that all annuities are bad, only snakes sell them and gave his interpretation on how an indexed annuity works and the advice that he offered his family members.
"Steer clear of annuities. The insurance company caps your return, invests your money in the markets and keeps all above the guaranteed cap. Example, they guarantee 4% a year to the annuity holder on $100,000. Then, they invest the entire $100,000 in stocks of their choosing. Imagine a year like 2013 when the stock market averaged returns of about 34%. In that year, the insurance company keeps 30% and gives the annuity holder their 4%... What a great deal. It is a terrible product and only snakes sell them. If you ever want out, it takes fierce phone calls and about two to three months to get YOUR money back from them. I know because I had to help relatives get out".
At first I thought it was comical how an "armchair" expert could have things so absolutely wrong and then I became concerned. I have conversations weekly with people who are clearly stressed over either their purchase of an annuity or own one or a handful of them and learn something about them that they didn't know when I provide them with a detailed Annuity Report Card. My point in this response is that seeking advice from someone that you know who may be very smart... may not be the best choice for your source of information. These are confusing, complex investment vehicles that and there are a lot of bad ones out there as well as bad people selling them. However, making an emotional decision about what to do from someone who doesn't understand what they are speaking about might just very well take a bad situation and make it even worse.
My advice is not to seek advice or even a second opinion, just get it from a qualified source and someone who is willing to tell you not only the good, but the bad as well. Getting those good and bad details in writing.. even better.
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Response: My first response to this question is that I don't have enough information to answer the question from a financial standpoint. In order to assess whether you are suitable to purchase an annuity I would have to conduct a full financial assessment. Since liquidity is one of the concerns in making this kind of investment, we want to make sure that you have enough money to afford that type of illiquidity in his portfolio.
Assuming you are financially suitable to make this kind of move, I would suggest that you have a very small window of opportunity to do so. Every annuity has a maximum issue age and once you exceed that age the product you are considering is no longer available to you. Looking at the entire spectrum of available products, once you hit age 75 the number of consumer oriented products that perform well diminishes significantly and again at age 80. Once you hit the age of 85, I'm not aware of any annuity product that I would recommend even if it were available. So here are a few things to consider before writing that check:
1. Make sure that you understand the liquidity of the annuity product you are purchasing completely.
2. Even though I don't use variable annuities in my practice, owning or purchasing one at age 83 isn't a great idea. You just don't have enough time to recover from any sort of market correction and the fees will eat you up.
3. Make sure that the annuity you are considering has some type of health care waiver. This allows for additional liquidity if you happen to need your cash while being under some sort of medical care.
4. Make sure there is no surrender charges at death. You certainly don't want your beneficiaries to pay any fees upon your death to collect their money.
Thanks so much for the questions Leon and if there is anything else I can do for you, please don't hesitate to let me know. Stay well.
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Response: Great question from Sue T. in Noblesville, IN. The very first question I'm asking any advisor that I'm meeting with to discuss annuities is "how many companies do you represent or are you contracted with?" Ask for a list to see what you will have access to. Let's face it, you can't possibly buy the most competitive product, from the best rated companies if the person you are speaking with doesn't have access to it.
Next I want to know about fees, caps and things that cost me money. Have the advisor prepare an outline of all of the contract limitations, things that will cost you money like expensive riders and go through them with you. If you are being presented with a annuity that has a rider, like an income rider or death benefit rider, ask if it's optional and why this vs. a lower cost product which will probably offer you better performance.
If the annuity has a bonus, don't jump to the conclusion that this is automatically a good thing. Ask if it's a cash bonus, if there is some sort of recapture or vesting schedule or is it paid to an "income account" accessed through exercising an income rider or annuitizing. These are critical to understand.
Last I want to learn about liquidity, how you access your money if you need it. How much can you take without incurring a fee and last but not least, what happens should you pass away while owning this contract.
I think these are some of the most critical questions you should be requesting responses to Sue and of course there are many more follow ups to them but at least this points you in the right direction.
Keep the questions coming.
Response: Thanks so much for the questions Sonja...there is plenty of dirt on the topic of annuity bonuses. It's interesting how even some of the most well read investors when you ask them why they purchased a particular annuity the first thing out of their mouth more often than not is "well I was paid a bonus". Wearing this like a badge of distinction as if they were so crafty they outwitted the insurance company and beat them like the gambler who is going to take down a Las Vegas casino. First off, there is no "getting over" on the insurance company. If you haven't notices, these are for profit companies and aren't in the business of giving money away. Having said that, I normally discourage my clients from entertaining a bonus annuity product as I do with most other annuity riders. Why?... because after the thrill of "being paid" wears off typically in the long run they end up costing YOU money. Let's take a look.
When you are paid a bonus it's either paid to you in cash, added to your deposit or if you have an income rider, it's added to your income account. The difference between the two is extreme. Funds in an "income account" or "income rider account" not only are costing you in fees which have a negative affect on the earnings of your actual cash value, but you typically either need to exercise that income rider or annuitize the contract to realize that value. I've seen cases where bonuses were used to offset surrender fees coming out of another annuity contract and the bonus was paid to the income rider account, not the cash value... this should never happen. Rule number one, don't own a rider that you aren't prepared to use at some point otherwise you are just tossing money away.
The alternative to being paid into an income rider account is when that bonus is added directly to your cash value.. a much better situation since that is real spendable money, but there are downsides here as well. Normally when you are paid a bonus is cash there is something called a "bonus recapture" schedule. It's a vesting schedule much like the surrender charge schedule on your annuity but it applies to your bonus. If you leave early, you give it back, it's that simple.
The questions that must be asked when you are being enticed with a bonus are:
Response: Let's face it... Annuity investing has always had a negative connotation. Ralph from Coral Springs wants to know why. Well Ralph in my opinion that negative cloud exists for a few reasons. Obviously the media portrays this asset class as a whole as a bad choice. Whether or not there are thousands of success stories out there, let's face it, negative news sells. It's much more interesting to read an article about the 82 year old widow who got burned than the 82 year old happy annuity investor. The other issue is that when the media portrays these products, it's done in mass. For example, high fees are normally discussed. Well, I would agree that high fees exist in the variable annuity market place... but that's one of 4 types of annuities that are available to the public. The problem is the public can't differentiate and suddenly ALL annuities have high fees and are bad investment options.
Secondly, I would agree that there are plenty of people who have purchased annuities and have had bad experiences. I would say that's true of any product a consumer could purchase. One investors experience does not make for the demise of an entire asset classification. As I said above, there are plenty of great products out there and plenty of fantastic planners and advisors using them in their practices, you just aren't going to read about them or see them on the news. Thanks so much for your question Ralph .
The more annuity bells and whistles you buy... the worse your performance will be.
Response: Thanks so much for the question Sam and here's the straight scoop. First of all the underlying fuel for a disgruntled owner of anything including an annuity is their expectations. When you sit in front of someone who is talking to you about market like returns with protection and bonuses and guaranteed income etc. people tend to get excited. What I have found in my 25 years of experience is that when it comes to annuities in general, consumers are sucked in by the flashy enticements like bonuses, income riders, roll up rates that they typically think is a guaranteed return and Death Benefit Riders. Consumers love the features and things that make these products sound fantastic... the downside is that they rarely if ever understand the affect of having these features included in their contract on the underlying performance of their investment. Investors don't typically complain about the 10% bonus a year or two later... what they complain about is the fact they learned some new terminology like what a cap is or that there was a fee for those riders and a vesting schedule for that bonus.
When I sit down with someone to discuss an annuity that they own or we are talking about putting funds into a new contract the very first thing that we talk about is the use of those funds. Are we buying an annuity for appreciation and growth or to produce income. Often those two varieties will lead us down two very different paths. I see so many annuity contract owners who come to me for an Annuity Report Card® who are unhappy because of their returns, but don't understand the very things that excited them about making the purchase is the same items that are causing their funds to perform poorly.
The lesson of the day is when it comes to annuities as well as so many other things in life... "you can't have your cake and eat it too". If you are buying annuities laced with additional costly features, don't expect your investment return to knock your socks off. Most often you can have one or the other but not both.
Thanks again for the question Sam.
Response: Thanks so much for writing in Robert.. I truly appreciate you taking the time to ask your question. As you know from reading or listening to anything I have ever published I am not a fan at all of rules of thumb. Everyone that walks through my door and interviews with me has a completely different set up circumstances. As a starting point for discussion, before I meet with a new perspective client I have them complete the Color of Money Survey. This is a simple test to give me an indication of their risk tolerance as well as other things that should be considered in determining asset allocation. As with any asset class, owning too much of one particular type of investment has it's risks. Individuals who were heavily invested in real estate over the last 10 years felt the affects of being heavily weighted there. Having too much of your money invested in annuities may not cause you risk of loss but instead you have liquidity concerns.
The two biggest gripes about annuities are fees and liquidity and if you are too heavily invested in annuities a number of things have gone wrong. Here are a few things to pay attention to:
Response: Thanks so much for the question Donna and income riders are probably the most misunderstood, oversold and least explained feature that can be added to an annuity. I can't tell you how many annuity owners I meet with that are so proud of the fact that they own an annuity that they were bonused 10% when they made the purchase, their money is growing at a guaranteed 6% rate and life couldn't be better... Then I do the Annuity Report Card on their contract and they find out that their real spendable cash is not growing at 6%, that's either the roll up rate that their "income account" is appreciating at. The learn that they are paying a fee for that income rider which is sapping the growth of their actual cash and that the bonus that they were paid was added to their "income account" and not their cash value. Typically the red flag that brings them to me is they see that their cash value is not growing nearly enough or as much as they anticipated.
A few things to understand about income riders:
Response: Thanks so much for the question Patricia. I am not a huge fan of broad stroking remarks like that and you should be careful of the source. Fear is a popular sales tactic and is used in all industries including the financial services industry, most often by competing asset classes. I think you'll find that equity managers who do not employ annuities put this type of information out to scare people out of buying them and into seeking their counsel to buy their widget. Having said that, there are SOME annuities that are very burdened by fees, but the impression is often given that ALL annuities share this trait.
There are four different types of annuities available today, and I will cover each of them as they relate to fees.
Immediate Annuities: Where you are basically trading a lump of your money for an income stream similar to a lotter payment has NO FEES. You aren't going to earn much money here.. but no fees non the less.
Simple Fixed Annuities: These are principal protected annuities that are very safe and pay a simple interest rate... also NO FEES. You know where interest rates are right now, so this variety doesn't get a whole lot of looks right now, but if rates should continue to rise will probably gain popularity once again.
Indexed Annuities: This also falls into the principal protected variety and the majority... but not all of these products have NO FEES. There are some exceptions to the rule here as some of them do charge a fee and if you start taking on income riders and/or death benefit riders those will always cost you a fee. It's worth noting that the best performing indexed products available today are the least exciting for they have no bonus enticements, flashy riders and all the other widgets that are easily sold but somehow mathematically don't look so good after a year or two. I'll save the rest of that story for another time.
Variable Annuities: Last but not least comes the infamous variable annuity. Gained popularity during the mid and late 80's when the markets where screaming along and know one cared about fees... until the bottom dropped out. The market corrected, people lost money which they didn't think they could ever lose, people wanted to get out because they were losing and didn't like that they had to pay a fee to do it and then the discussion of costs became important. People filed complaints left and right and since then ALL annuities took on a bad flavor. I don't use variable annuities with my clients because of the fees and my opinion is that there are much more efficient ways to expose yourself to the market than using this type of vehicle. You'll pay on average between 2.5% and 5% in fees especially again if you start tacking on income riders and death benefit riders... remember as a general rule if you are buying guarantees you are going to pay for them and will most definitely play against the total return of your investment.
Summary: All annuities to not have fees. Some do and some additional benefits that you add to your contract will certainly cost you as well. My advice is to go lean and mean and try not to make what is supposed to be an investment vehicle into something that it's not... like a long term care policy or life insurance policy. Everyone has their own opinion though, and now you have mine. I hope you learned something Patricia and I thank you for your question.
Carl Barnowski has 25 yrs. of experience as a retirement income expert specializing in principal protected annuities.