Many annuity businesses, according to Fisher, mislabel variable annuities as “safe investments.” He claims that this is untrue, and that a variable annuity can really lose money. Fisher is correct: variable annuities can come with a lot of risk.
Why does Fisher Investments not like annuities?
Annuities come in a variety of forms, but the two most common are deferred and immediate.
- Deferred annuities: You put a big sum of money into an insurance company and let it grow tax-free until a specified time in the future.
- Immediate annuities: You put down a big sum in exchange for a guaranteed income stream that begins when you make your initial investments.
Additional annuity categories exist within the deferred and immediate annuity categories, such as fixed and variable annuities.
In most cases, fixed annuities guarantee a specific interest rate. The payoff is a predetermined amount, comparable to that of a Certificate of Deposit (CD). Although the value of your investment will not fluctuate due to market fluctuations, the rate of return will be lower than that of other annuities. In addition, interest rates might fluctuate at the end of a predetermined time period, and you may be able to earn a greater rate from a CD in certain market conditions.
Variable annuity premiums, on the other hand, are invested in subaccounts that are similar to mutual funds. The dividend is contingent on the underlying investments’ performance. Variable annuities may provide the biggest return potential but also the highest potential volatility and expenses when comparing annuities.
- When you remove your winnings, they are taxed as ordinary income rather than capital gains tax rates, which are generally lower.
- Limiting your potential losses with annuity riders—or contract modifications—might also restrict your gains. This feature might also severely limit the long-term return potential of your portfolio.
Why do annuities have such a bad reputation?
Let’s be clear: almost every investment has a fee attached to it in some way. Annuities, on the other hand, take that concept to a to new level.
To begin with, annuities are frequently (though not always) pushed by pushy salespeople who profit handsomely from your purchase. Those commissions can easily exceed 10%, and they’re frequently factored into the annuity’s operating costs, which means you, the buyer, pay for them.
When it comes to running costs, it’s fairly uncommon for annuities, especially variable ones, to impose yearly fees of 3% to 4%. Actively managed mutual funds, on the other hand, may only charge half that amount. Granted, you won’t get guaranteed income for the rest of your life if you invest in a mutual fund, but it’s something to think about.
Another thing to keep in mind concerning annuities is that they usually come with surrender charges, which means that if you try to cancel your contract, you’ll be charged a large amount. During the first year of your annuity, this cost can be as high as 7%, but it will normally decrease by roughly 1% annually during your surrender period until it is fully gone. However, depending on the nature of your contract, some annuities allow you to remove a modest percentage of your account value each year without incurring a surrender charge.
Why should I stay away from annuities?
Scott Hanson, co-CEO of Allworth, warns retirees about one of the most popular – but oversold – insurance products.
It’s critical to educate yourself about what you’re purchasing and why you’re buying it when it comes to your finances.
This is because some popular investment items may be appropriate for some people, but they are often inappropriate for the majority of those who are tempted to buy them.
Annuities are one of the most oversold investing options available. Annuities are unusually complicated contracts between you and an insurance company in which you pay a big sum of money in exchange for a regular payment. These payments could be made for the rest of your life or for a set period of time.
Annuities come in a variety of shapes and sizes. Variable annuity returns may be based on the performance of a specific mutual fund; indexed annuity returns are based on a specific index (such as the S&P 500); and fixed annuity returns are based on a certain interest rate.
While an annuity may be a good investment for some people, because they often earn a large fee for the salesman, it is important to identify the primary objective of the person suggesting the annuity.
All else being equal, we rarely recommend an annuity at Allworth Financial. The following are four explanations for this.
The fees for variable annuities can be extremely high
The recurrent fees are one of the most significant disadvantages of variable annuities. These are used to cover the risks and costs of safeguarding your funds. An annuity charge, for example, could be around 1.25 percent of the amount you’ve invested.
However, when compared to variable annuities, both indexed and fixed annuities may have cheaper basic fees. However, whether you choose an indexed or fixed annuity, you’ll almost certainly be pressured to add extra “riders” or “customized improvements” (such as death benefits or long-term care).
Aside from fees, surrender charges are one of the most costly components of annuities. When you remove money in excess of your normal payout, you will be charged a surrender fee. (Even if you’re in desperate need of cash.)
The amount of a surrender charge decreases the longer you hold the annuity, but let’s say you have an emergency in “year three” and need to take an additional $10,000. The surrender cost could be as high as 5% of the withdrawal amount, implying that you’ll have to spend $500 only to reclaim your own money.
As a reminder, a $500 penalty isn’t the only thing that’s costly; the $500 deduction also affects the principle of your annuity account.
The returns on annuities don’t always match those received from the market
People buy indexed annuities in the hopes of getting interest returns that “mirror” those of a stock index. You’d imagine that if that specific index performed well in a given year, the annuity’s returns would likewise perform well.
But this isn’t always the case. This is due to a little thing called a “participation rate,” which is used by many insurance firms. That is, they “limit” your returns so that your investment can only rise by 80% of the fund’s growth, for example.
Breaking free of an immediate annuity could be impossible
An instant annuity, the most basic sort of annuity, is a long-term investment plan in which you make a lump-sum deposit and it begins giving you a guaranteed revenue stream right away (monthly, quarterly, or annually). These payments could last a few years or for the rest of your life, depending on your agreement.
The fact that once you acquire an immediate annuity, you’re not just trapped with it, but your payments can’t be passed on to a beneficiary, so the money stops coming the day you die is a huge disadvantage.
Some insurers may allow you to switch your immediate annuity to a different type of annuity, but even if they do, you’ll almost definitely be charged with a slew of fees and taxes.
Annuities typically pay the seller high commissions
As previously indicated, buying an annuity usually entails paying a large commission to the seller on top of your investment. In other words, you won’t be able to send a commission check to the annuity salesperson; instead, the money will be deducted from your deposit.
What is the cost of these commissions? They can range from 6% to 8%, or even more. That means that if you buy an annuity for $200,000 and the commission is 7%, only $186,000 of your money is invested for you (before any extra expenses).
Aside from the commissions, fees, and inflexibility (high surrender charges), annuities have a ‘plus’ reason to avoid: they have complicated tax status. For instance, the money you earn from a deferred annuity is treated as ordinary income and is taxed accordingly (rather than at the lower, much more tax-friendly long-term capital gains rate).
With that in mind, if you still want to buy an annuity, make sure you only engage with a fiduciary advisor that operates in your best interests 100 percent of the time (as all our advisors do). This will assist you in avoiding potential conflicts of interest. Because there are advisors who only wear their fiduciary hat on occasion,
Are 3 year annuities a good investment?
Fixed annuities are a good investment for anyone searching for a secure, tax-advantaged option to earn a guaranteed return on their retirement assets (3 to 10 years).
Fixed annuities are fairly similar to CDs in terms of how they work. Both vehicles provide a secure way to store money by requiring you to lock your money away for a period of time, resulting in higher interest rates than savings accounts. There is liquidity, but taking money out before it matures usually comes with a penalty (unless you purchase a product that allows for free withdrawals). Fixed annuities usually have better rates than CDs, but they don’t have the FDIC guarantee that CDs do. Instead, pay attention to the insurer’s credit rating as an indication of their ability to pay claims.
If you want to learn more about fixed annuities, check out these articles.
What are pros and cons of annuities?
Annuities are no exception to the rule that nothing in the financial world is without flaws. The fees associated with some annuities, for example, might be rather burdensome. Furthermore, while an annuity’s safety is appealing, its returns are sometimes lower than those obtained through regular investing.
Variable Annuities Can Be Pricey
Variable annuities can be quite costly. If you’re thinking of getting one, make sure you’re aware of all the costs involved so you can choose the best solution for your needs.
Administrative, mortality, and expense risk fees all apply to variable annuities. These fees, which typically range from 1 to 1.25 percent of your account’s value, are charged by insurance firms to cover the expenses and risks of insuring your money. Expense ratios and investment fees differ based on how you invest with a variable annuity. These costs are comparable to what you would pay if you invested in a mutual fund on your own.
On the other hand, fixed and indexed annuities are rather inexpensive. Many of these contracts do not have any annual fees and only have a few additional costs. Companies may typically offer additional benefit riders for these in order to allow you to tailor your contract. Riders are available for an extra charge, although they are absolutely optional. Rider costs can range from 1% to 1% of your contract value every year, and variable annuities may also charge them.
Both variable and fixed annuities have surrender charges. When you make more withdrawals than you’re authorized, you’ll be charged a surrender fee. Withdrawal fees are normally limited throughout the first few years of your insurance term. Surrender fees are frequently substantial, and they can also apply for a long time, so be wary of them.
Returns of an Annuity Might Not Match Investment Returns
In a good year, the stock market will rise. It’s possible that this will result in extra money for your investments. Your investments, on the other hand, will not rise at the same rate as the stock market. Annuity fees are one explanation for the disparity in increase.
Assume you purchase an indexed annuity. The insurance company will invest your money in an indexed annuity to match a certain index fund. However, your earnings will almost certainly be limited by a “participation rate” set by your insurer. If you have an 80 percent participation rate, your assets will only grow by 80 percent of what the index fund has grown. If the index fund performs well, you could still make a lot of money, but you could also miss out on some profits.
If your goal is to invest in the stock market, you should consider starting your own index fund. If you don’t have any investing knowledge, you should consider employing a robo-advisor. A robo-advisor will handle your investments for you for a fraction of the cost of an annuity.
Another thing to consider is that if you invest on your own, you would most certainly pay lesser taxes. Contributions to a variable annuity are tax-deferred, but withdrawals are taxed at your regular income tax rate rather than the long-term capital gains rate. In many places, capital gains tax rates are lower than income tax rates. As a result, investing your after-tax income rather than purchasing an annuity is more likely to save you money on taxes.
Getting Out of an Annuity May Be Difficult or Impossible
Immediate annuities are a big source of anxiety. You can’t get your money back or even pass it on to a beneficiary after you put it into an instant annuity. It may be possible for you to transfer your funds to another annuity plan, but you may incur expenses as a result.
You won’t be able to get your money back, and your benefits will be lost when you die. Even if you have a lot of money when you die, you can’t leave that money to a beneficiary.
How many clients does Fisher Investments have?
Fisher Investments manages $159.6 billion in assets and provides investment advice to 84,394 clients (1:57 advisor-to-client ratio).
Does Suze Orman like annuities?
Suze: Index annuities aren’t my cup of tea. These insurance-backed financial instruments are typically kept for a specified period of time and pay out based on the performance of an index such as the S&P 500.
Does Dave Ramsey like annuities?
Annuities are burdened by a slew of expenses that eat into your investment return and keep your money locked up. If you want to get your hands on the money you’ve put into an annuity, you’ll have to pay a fee. This is why annuities are not something we endorse.
Remember that annuities are essentially an insurance product in which you transfer the risk of outliving your retirement savings to an insurance provider. And it comes at a high cost.
Here are some of the fees and charges you’ll find associated to an annuity if you’re curious:
- Surrender charges: If you’re not paying attention, this can get you in a lot of trouble. Most insurance firms impose a limit on how much you can withdraw in the first few years after purchasing an annuity, known as the surrender charge “The term of surrender charge.” Any money taken out in excess of that amount will be subject to a fee, which can be rather costly. That’s on top of the 10% tax penalty if you withdraw your money before reaching the age of 59 1/2!
- Commissions: One of the reasons why insurance salesmen enjoy pitching annuities to people is that they can earn large commissions—up to 10% in some cases! Those commissions are sometimes charged individually, and sometimes the surrender charges we just discussed cover the fee. Make sure you inquire how much of a cut they get when you’re listening to an annuity sales pitch.
- Charges for insurance: These could appear as a bill “Risk charge for mortality and expense.” These fees cover the risk that the insurance company assumes when you buy an annuity, and they normally amount to 1.25 percent of your account balance per year. 3
- Fees for investment management are exactly what they sound like. Managing mutual funds is expensive, and these fees pay those expenses.
- Rider fees: Some annuities allow you to add extra features to your annuity, such as long-term care insurance and future income guarantees. Riders are optional supplementary features that aren’t free. There is a charge for those riders as well.
What is a better alternative to an annuity?
Bonds, certificates of deposit, retirement income funds, and dividend-paying equities are some of the most popular alternatives to fixed annuities. Each of these products, like fixed annuities, is considered low-risk and provides consistent income.
Why do financial advisors push annuities?
The goal of the bank and its securities division is to make money. This would be acceptable if all of the bank’s product offers were compensated equally, allowing for unbiased advise. This is not the case, as annuities offer the bank and its sales force with the most money (6-7 percent average commission for the salesperson).
Annuities are expensive because they are insurance-based products that must cover the cost of the benefits they provide. Many annuities, for example, guarantee that your principal will never be lost while still allowing you to gain money through separate accounts comparable to mutual funds. The reality is that your beneficiaries, not you, are guaranteed your principle at your death, which is a better explanation of this offer. If you were nearing retirement during the financial crisis, this assurance was of little use.
A variable annuity’s average expense, according to Morningstar, is 2.2 percent. If you put $10,000 into an annuity and the market yields 8%, you should have $30,882 after costs in 20 years. Instead, you might have $44,498 if you invested in a 0.20 percent index portfolio; that’s an extra $13,616!
The annuity is marketed to younger investors as a tax-deferred investment vehicle. A variable annuity will provide you all that, but at a price. I’ve discovered that the best vehicle for investors who have maxed out their 401ks and IRAs and are looking for tax-sheltered retirement savings is a taxable, tax-efficient portfolio. With the growing popularity of Exchange Traded Funds (ETFs), an investor can establish a tax-efficient portfolio for less than 0.30 percent of their portfolio value.
Why do people fall for annuity bait and switch schemes? It all boils down to the salesperson’s persuasion and the bank’s play on the customer’s anxieties of investing. Many bank customers would never invest in the stock market because they believe it is too hazardous. The annuity looks to provide the consumer with the protections he or she seeks. Always keep in mind that there are no free lunches. If something sounds too good to be true, it probably is. There are several options for managing investment risk that cost a tenth of what an annuity does. These solutions can be explored with the assistance of a fiduciary fee-only advisor.
Long-term contracts
Annuities are long-term contracts that last anywhere from three to twenty years, and they come with penalties if you violate them. Annuities typically allow for penalty-free withdrawals. Penalties will be imposed if an annuitant withdraws more than the permissible amount.
