Buyer Beware: Annuities for Your Retirement Savings
There are some situations where an annuity makes sense for your retirement savings. Let’s quickly discuss those situations. First, a lifetime income annuity that pays a monthly income may make sense if you are in retirement and have very little guaranteed income (such as Social Security or a pension) but you have significant other savings. It’s like buying a personal pension plan to get your guaranteed income up to an acceptable level. Second, buying a deferred annuity during your working years may make sense if you want to save for retirement, but you either do not have a retirement plan at work or you’ve maxed it out and you’re looking for additional investment alternatives. The tax deferred status of annuities provides value for you in this situation. In both scenarios you should make sure the product you buy isn’t full of exorbitant fees or long surrender charges. It pays to shop around for them and find low expense options. Certain insurance companies offer “no-load” variable annuities, which are sold directly to investors and do not require commissioned sales people or brokers.
Now comes the “buyer beware”side of annuities. The biggest red flag that comes to mind is when you are being offered a deferred annuity (fixed or variable) while you are still saving for retirement. Especially if it’s in your IRA or a rollover from your 401(k) plan. Why would you pay the fees associated with an annuity that is already in an account that is tax favored? It seldom makes sense. The additional fees may push the annual cost up anywhere from 1% to 3%. Annuity.org reports average fees on a variable annuity are 2.3 percent of the contract value and can be more than 3 percent. You may be told that there’s a valuable death benefit or some tough to understand income rider, but they are seldom worth the extra cost.
Also, beware of any annuity with a surrender charge that lasts more than 5 years. You may be told that it’s in place so that the insurance company can manage the account more effectively knowing that the money will probably not leave for a set time period. In reality, the back-end surrender charge is in place so that the insurance company can re-coup the commissions they’ve paid by charging you high fees and forcing you to keep your annuity in place because of surrender charges.
Many annuities are SOLD within IRAs for the wrong reason. Let’s put the emphasis on the word SOLD. It’s because many financial advisors sell products to make money and annuities often generate the highest commissions. This is often due to something called breakpoints, which do not exist with annuities. Mutual funds generally have breakpoints which means they charge less in upfront sales charges when you invest more. For instance, when you buy Class A shares of many mutual funds (these are the shares that have a front-end load), you might pay 5.75% if you invest $25,000 or less. But the load goes down as your investment increases. At $100,000, the load might be 3.50%, while at $250,000 it might be 2.50%. These loads are primarily used to pay advisor commissions. But most variable annuities pay 5% to 7% regardless of the size of the sales. Thus, many advisors are motivated to sell annuities to double or triple their commissions when compared to mutual funds. I stay away from expensive annuities or loaded mutual funds because there are much cheaper options that do not trap you in them with back-end surrender charges.
If you are being offered an annuity for your IRA or IRA rollover, be sure to question it. Why do I need an annuity in an account that is already tax-deferred? Why shouldn’t I invest this in low-cost mutual funds or ETFs? How much in commissions is this generating? Why would I invest my money in a product that traps me in it with back-end surrender charges? Aren’t there better, lower-cost options? If there are not good answers to these questions, then buyer beware.