Debunking conventional annuity wisdom
Even though sales continue to climb, annuities are without a doubt the most misunderstood financial product ever.
Some current beliefs and opinions concerning annuities that are generally accepted by most people are either completely incorrect or are in dire need of further clarification.
Let’s take a look at the ones I hear the most:
If I die early, the insurance company keeps the money
This is the most common incorrect blanket statement I hear from most annuity haters or doubters. What this phrase describes is a “Life Only” income annuity that has been annuitized (which means to create payments). When you annuitize an annuity, “Life Only” is only one of more than 10 choices you have to structure exactly how you will receive your lifetime payments. Structuring the annuitization “Life with Installment Refund” or “Life with Cash Refund” will ensure that the insurance company won’t keep a penny, and all the money will go to you or your listed beneficiaries.
All annuities are expensive and have high fees
Variable Annuities are the main culprit when it comes to high fees. The average annual fees of load variable annuities are typically between 2% and 4% every year and for the life of the policy. I think the reason this “high fee” for all annuities belief exists is because variable annuities represent the vast majority of annuities sold every year, so most people incorrectly assume that high fees are the case with every annuity type.
Many annuities have no annual fees at all. For example, Single Premium Immediate Annuities, Deferred Income Annuities (aka Longevity Annuities), and Fixed Rate Annuities have no annual fees. Even Indexed Annuities without riders (i.e. attached benefits) have no annual fees.
All annuity commissions are high
Variable and indexed annuities typically pay a high commission to the writing agent, but some annuity types like a Single Premium Immediate Annuities pay a very low commission.
Here’s a few tips to know if the commissions are high with the annuity your are considering. The longer the surrender charges, the higher the commission. The more complex the annuity (i.e. variables and indexed), the higher the commission. Deferred annuities with attached benefit riders are where most high commissions can be found, and these types of annuities do represent most annuities sold today.
Never buy annuities when interest rates are low
This blanket statement can be both true and false. No one knows when or if interest rates will move, but everyone’s specific situation at the time you actually need income will dictate if an annuity is an appropriate strategy.
Some people need a lifetime income stream right now, so interest rates don’t matter as much in those cases. In addition, looking at your specific time value of money calculations might show that receiving money in the present is worth more than waiting till a future date. Current interest rates also affect deferred annuity decisions as well, and should be examined on a case-by-case basis.
I can get a lifetime income stream and growth at the same time
This is the typical dream that is being sold by too many agents, and is a common belief that I unfortunately hear from misinformed consumers. I blame both agents and the industry for allowing this ridiculous too good to be true belief to exist.
The reality is that when you decide to take a lifetime income stream from an annuity (either through annuitization or income rider drawdown), that payment amount is deducted from the contract total. The depletion of the total is a reality, and the hope of an accumulation or investment value offsetting the annual income stream is a dream that doesn’t have a good chance of happening.
Indexed annuities are market growth products with no downside
In addition to random feel good words like “hybrid” being used to push fixed-index annuities to the public, the dream of market upside with no downside probably drives most sales of this new strategy. Because annuities go pretty much unregulated at the state level, the fact is that most of the advertising and promotion of indexed annuities would never be allowed under typical SEC type scrutiny. Because of this oversight apathy, annuity promoters on the Internet, TV, and radio are pushing the envelope to achieve annuity sales any way possible.
The reality is that indexed annuities were designed to compete with CD returns, not the market. The principal is fully protected because it’s a fixed annuity, but the limited upside and being able to lock in gains only one day a year is fact that needs to be clearly understood.
All annuities are bad for the customer and good for the carrier
This is one that keeps showing up in the comments section and it’s just uninformed. Annuities are transfer of risk products that solve for specific goals. Having an income stream that you can never outlive is a value that only annuities can provide. That is the most pro customer solution on the planet in my opinion. Yes, the insurance company is in business to make money, but the products and strategies offered can truly help solve problems when allocated properly.
At the end of the day, a lot of the blame for the misunderstanding surrounding annuities falls squarely on the shoulders of the annuity industry and too many hype driven annuity agents. The reason that most annuity conventional wisdom is incorrect is due to the lack of education of the buying public. These false assumptions are also driven by the unregulated advertising of annuities that typically frames the product incorrectly within the buyer’s mind.
Conventional wisdom can be clarified by reading the annuity policy. Regardless of what you think, or what some agent has told you, the annuity contract will reveal exactly what is going to happen. Ask to see a specimen policy of the annuity you are considering, and don’t believe current annuity conventional wisdom at face value.
Always validate all of the facts for yourself before buying any annuity.
Originally published 4.1.2014 by MarketWatch.com – http://www.marketwatch.com/story/debunking-conventional-annuity-wisdom-2014-04-01