4 Things Every Retiree Must Know Before Buying an Annuity
Why is the world of retirement finances so scary? The answer is one you’ve probably come to know all too well: the future is uncertain. You’re uncertain about how long you’ll live because, after all, you don’t want to outlive your assets. And the nightmarish vision of forever losing one’s nest egg to an uncertain stock market can reel like an old-school motion picture.
For some, this is just a little jitter in the stomach every now and again, and for others, the fear of an unpredictable future is persistent and gnawing. But it is the same for everyone: the lack of full assurance is a nasty pill no one wants to swallow.
These products offer some sort of a guarantee; for instance, that you’ll never lose your principal amount or that they will pay you a set amount until the day you die. In other words, it comes with a reassuring promise to put your fears and uncertainty to rest, which is probably why annuities are such a popular choice nowadays (and why it is such an easy sell for agents).
But here’s what you need to understand about annuities: all “guarantees” will come at a very high cost. Insurance companies are masters at risk and reward, so they aren’t going to offer you a product in which they lose at the numbers game. I’m not here to say that all annuities are the spawn of hell like some advisors are in the habit of doing. But I do want to make sure you don’t buy one without knowing the downsides and complications. There are many of them, but here are just a few.
The Upfront Promises Can Change—Check the Fine Print
As I just said, these products are complex. Some disclosure documents are 100 pages longs. In fact, I’ve come across some variable annuity disclosures that were over 700 pages (some light reading for an August evening, right?).
And within the acres of legalese, there are often some measures that will protect the insurance company if times get rough. For instance, from what I’ve seen, they can increase rider fees, lower interest rate caps, increase spreads, and let participation rates plummet. To translate, in simple terms, that means “if the promise we made you is getting us into trouble, we’ll just back out of it.”
I know this from personal experience. Back in my earlier, more naïve days of financial planning, I suggested that my dad buy an indexed annuity. The product promised a 110% participation rate, which means that whatever the S&P 500 was doing, he would get 110% of that. But I noticed something peculiar tucked away in the pages: that rate could drop to 50% at the company’s discretion. We talked with the company representative and he assured us again and again how unlikely it was for it to drop. So, I dismissed it and sold it to my dad.
Guess what fell to 50% the very next year?
You see, what you have to realize about annuities, is that the company is always doubly protected. Like the old saying goes, if it sounds too good to be true…well…I think you know the rest.
You Can Really Tie Up Your Money
The worst part of many annuities is that they have surrender periods. In the case of my dad, his surrender period was seven years. Even though he hated it, he couldn’t get out of his annuity without paying steep surrender penalties. Typically these periods are around seven to twelve years, but I’ve seen some as high as seventeen. And the penalties for cashing out early? They might be anywhere from 8-20% of your principal.
This doesn’t necessarily mean annuities are terrible products. It just means they are really, really hard to escape. So make sure you understand what you are getting into!
There Are Often Large Fees—Or Whatever They Call Them
The fees in an annuity are usually as high as 3-4% once you add up the rider fees, mutual fund fees, and mortality and risk fees.
And what if someone told you that the annuity they’re selling doesn’t have any fees? In that case, just remember that the insurance company will make that money back somehow. For instance, in a fixed annuity, they often have a cap on the amount of return you can get. I’ve found that these kinds of hidden costs come out to around 3-4% most of the time—maybe even worse. Just because they aren’t called fees, doesn’t mean they won’t cost you big time!
There Are Huge Conflicts of Interest
Agents who sell annuities often make high commissions. I’ve seen them as high as 10% upfront, maybe even more. And, for many annuities, agents aren’t even required to have a securities license to sell them because the annuity is considered an insurance product (even if it requires the salesperson to give investment advice). Here’s where that can get really sticky: you don’t have to disclose any conflicts of interest for insurance products. Therefore, a salesman can sell you an annuity without telling you about his fat commission. You can see why this has led many experts in the industry to the conclusion that annuities are sold, not bought. The products you buy should help your retirement plan. It shouldn’t help someone else’s and hurt yours in the process.
The Bottom Line
I’m not against the annuities as long as the buyer is making the choice after a fair representation of the pros and cons, but that is exactly the problem: It isn’t very often that people are given a fair representation that isn’t overblown with sales propaganda. That is why it is always a good idea to put the brakes on before getting into an annuity. Think about getting a second (or even a third) opinion. You won’t regret it.
If you want a second opinion on a specific annuity option and whether it is right for you, you can always call Seniormark at 937-492-8800. We specialize in the retirement transition, and we are here to help!