Annuities (Q & A)

Aug 2015

rick -2




Q         Hi Rick:

Thanks for your Money Matters articles in the Observer.  My question with the demise of the defined benefit pension and the uncertainty of Social Security in the future, what is your opinion of annuities?   I have read there have been changes to fix the negatives of annuities sold in the past.  To make things even more confusing there are many different types of annuities:  immediate, fixed, variable and indexed, to name a few.  Insurance salespeople make this sound like the best thing since sliced bread.  I have just retired and am in the process of consolidating my 457, 403(b) and IRAs.


A         Dear Jim:

First, congratulations on your retirement; I hope you have a long and comfortable retirement.


With regards to annuities, you are correct, the salespeople do make them out as if they are  best since sliced bread, but it is important to realize that they are salesmen and all too often they are looking only at their commissions from the sale of annuities and not what is good for the investor.  On the whole, I don’t have a problem with certain types of annuities while with others, I do.  The annuities that most trouble me are variable annuities. The reason why variable annuities trouble me is the fact that most of them are stuffed with high fees and severe adverse tax consequences.  The salespeople like to tout the idea that annuities will save you on taxes; however, that is not the case particularly with variable annuities.  When you withdraw money from a variable annuity it is taxed at your ordinary income bracket.  If you had invested in those mutual funds outside the annuity you would have been taxed a capital gain rate which is substantially lower than your ordinary income bracket.


Other types of annuities that I am not a fan of are ones that have substantial penalty provisions.  Some annuities if you withdraw money before a 10 or 15-year period you have to pay a penalty.  That makes no sense to me.  At most, I only want an annuity that has a five-year penalty period at best.  Why should I have to pay a penalty to take my own money out?  The reason why many annuities have high penalties is so they can pay the salespeople more in commission.  Therefore, any annuity that has a long surrender period or high surrender charges are annuities that I avoid.


What many people are pushing today is what is known as immediate annuities.  In an immediate annuity what you are typically doing is buying yourself a pension.  In these types of annuities, depending upon your initial investment, the annuity company will guarantee you a set amount of money per month for the rest of your life. For many people who like the certainty of knowing exactly what they’re going to receive on a monthly basis, these types of  annuities can work for them.  However, in no situation would I put 100 percent of someone’s money into an immediate annuity. The downside of an immediate annuity is that if you decide down the road that you want to cancel the annuity, you cannot. Once the money is with the annuity company, you have lost control of the principal; all you receive is your monthly income.


For a conservative investor who is looking for an alternative to CDs, fixed annuities or equity-index annuities can be appropriate; particularly, for someone who does not want any principal fluctuation.  In addition, for the conservative investor, if they want to buy a private pension, an immediate annuity can be appropriate.


Whether you buy an immediate annuity, fixed annuity or an equity-indexed annuity, the key is to shop around.  There are vast differences amongst annuities even within companies.  It’s not unusual for companies to offer four or five different types of annuities.  The key for you and me as investors is to invest in ones that are low cost and ones that give the investor a fair return.  One key to knowing that an annuity is investor friendly is to focus on the surrender charges.  When you see surrender charges for over seven years, you know that it’s not an investor friendly policy.  Rather, it is a salesman friendly product.


Buying annuities is not easy because it does require you to shop around and receive competitive bids.  It is sometimes difficult to compare different annuities because the companies purposely make the contracts difficult to understand.  However you must shop around and whatever you do  you can’t let the salespeople push you into a product that’s inappropriate for you.


Good luck!