Annuities: The Good, the Bad and the Ugly

There is no one magic investment strategy to achieve your goals. Knowing whether an annuity is a good, bad or ugly option for your strategy is important.

When you mention the word annuity, you’ll get all sorts of reactions. Some of those reactions will be positive and some will be negative. The positive reactions will generally be from folks that own an annuity and it’s doing exactly as needed. The negative reactions will come from people who were sold the wrong annuity, it didn’t accomplish what they needed, or they were sold one they didn’t need. There are also those that really dislike annuities and can’t say why.

The two categories of annuities: Fixed and Variable. Then there are different types and variations of annuities within those categories.

Fixed Annuities

These are annuities where you have no risk from losing your money in the stock market, you’ll get your initial investment back at the end of the term. For the most part, the insurance company is taking the risk. Fixed Annuities are referred to as Immediate annuities, Index Annuities and Multi Year Guaranteed Annuities (MYGA).

The Good:

Security: The Immediate and Index annuities may offer a guaranteed lifetime income option. Since the number one fear going into retirement is the fear of outliving your money, annuities with an income benefit attached can help by providing a lifetime income stream. Besides a pension and social security (which has been called the largest annuity in the world) only annuities can provide you with a lifetime income guarantee.

Fees: Most of the fixed annuities have either no fees or very reasonable fees.

Risk: Fixed annuities are considered safe because they will not risk your principal in the stock market. You will get your initial investment, the principal, back at the end of the term, guaranteed by the claims paying ability of the insurance company.

The Bad:

Surrender Terms: Some annuities have long surrender periods, and high surrender charges. The period is the number of years you commit your money to the insurance company and the surrender charge is the penalty you will pay if you take money out of your annuity early. There are exceptions. Almost all annuities will allow you to get to the money in case of death and some will allow you to get to it in the case of disability, terminal illness or if you are admitted to a skilled nursing facility. Some annuities also will allow for a yearly withdrawal of a portion of your money without penalty, usually 5-10%/year. The term length varies depending on the annuity and company.

Returns: With the lower risk, comes potentially lower returns.

Variable Annuities

These types of annuities fluctuate with the stock market. They can offer lifetime income riders and some offer death benefits.

The Good:

Security: Variable annuities offer lifetime income riders for a guaranteed income for life. Some annuities also offer death benefit riders for legacy planning. Unlike a Fixed Annuity where the income is consistent, income payments from a Variable Annuity can fluctuate.

Returns: With higher risk, comes the potential for higher returns. (You’ll see this again in the bad section.)

The Bad:

Surrender Terms: Same as above.

Risk and Performance: There is risk being invested in the stock market. The greater the risk, the greater the risk of loss. This is where you want to make sure you know what you want from your annuity. If is just an immediate lifetime income stream, then performance may not be as critical. If it is for growth or legacy, then be mindful of how the annuity is invested. There are variable annuities available that often lag in performance against specific indexes even though they are mostly invested in subaccounts that are essentially mutual funds. Most of the variable annuities available today are built on algorithms or they force you to own risk adjusted funds that are constantly moving your money back and forth between stocks and bonds. So instead of staying fully invested, your money is getting pulled in and out of the market based a computerized program.

Fees: These can get high as you add on benefits/riders. When people complain about annuities being expensive, they are typically talking about variable annuities.

The Ugly:

Too often the client does not understand what they bought. There are the risks of being in the stock market, rider fees and expense fees. It is important to understand how expense fees associated with the fund within the annuity add up. Whether there are gains in the account, or losses, the all fees are still deducted.

Variable annuities are sold by prospectus, which contains detailed information about investment objectives and risks, as well as charges and expenses. You are encouraged to read the prospectus carefully before you invest or send money to buy a variable annuity contract. The prospectus is available from the insurance company or from your financial professional. Variable annuity subaccounts will fluctuate in value based on market conditions and may be worth more or less than the original amount invested if the annuity is surrendered.

In Conclusion:

Annuities are great when used for the right reason and when it addresses the customer needs and goals.

I’m an advocate for people to get the best possible investment advice and educated along the way. If you have an annuity but you have no idea how much in fees you are paying or what that annuity is doing for you, you probably need a second opinion on it.

In the end, not all annuities are created the same. Much like stocks and mutual funds, some are good, and some are not so good. Do your research and make sure an annuity is in line with your goals and objectives before you buy one.

Need help deciphering an annuity that you already own? Contact us, we are happy to help.