Myths About Annuities
Aggressive marketing and messaging about high fees, charges for surrendering them early, and potentially disappointing returns compared to stocks are just some of the reasons annuities have, at least in some people’s minds, become the black sheep of retirement vehicles.
Numerous financial professionals however, argue that there’s a long list of myths and inaccuracies surrounding annuities. And those myths are causing people to lose money by missing out on a retirement option that can offer valuable benefits, particularly at a time when pensions have largely become a thing of the past.
Myth No. 1: All Annuities Are Bad
There are many types of annuities, and categorizing them all as bad choices is an oversimplification.
Like any financial instrument, annuities have pros and cons. In addition, there’s a significant difference to be aware of between a variable annuity and a standard fixed-rate annuity.
A standard fixed-rate annuity, which guarantees the return of principal, acts much like a tax-deferred version of a bank certificate of deposit. The money invested is guaranteed to earn a fixed rate of return throughout the accumulation phase of the annuity. During the payout phase, the balance invested, minus payouts also continue to grow at this same fixed rate.
A variable annuity, on the other hand, can be invested in volatile, high-growth funds. As the name implies, the value of your investment varies depending on the performance of the investment options you choose.
Some types (of annuities) simply aren’t right for some people, just as some mutual funds or other investments are unsuitable for some people. But some annuities are a perfect solution for some people because they do things no other financial product can.
Do some annuities have high fees? Yes. Are there annuities out there that are very confusing? Absolutely. Do I think it’s smart to put grandma into a 15-year annuity surrender period? No, but does it happen? All the time and that’s why they get a bad reputation.
Myth No. 2: Annuities Have High Fees
Again, it depends on the type of annuity in question.
Fixed annuities have no consumer fees unless optional riders are added.
The simplest type of fixed annuity is the multi-year guaranteed annuity. It is the annuity that is often compared to a CD because it offers a set rate of interest for a specific period of time. This type of annuity is tax-deferred and, importantly, the interest rates on these annuities usually beat those of CDs with the same term.
Other annuities to keep in mind that typically have no fees include immediate annuities, deferred income annuities (longevity annuities), and fixed indexed annuities.
Variable annuities do have ongoing fees, which are deducted from investment earnings in the same way mutual funds charge investment management fees. Additionally, there is a mortality fee. The key with these annuities, which offer growth potential, is to shop around to avoid the pricier options, said Nuss.
Investors can avoid fee-heavy variable annuities by comparing fees before buying. Keep your eyes open and ask questions.
And perhaps the even bigger takeaway is that not all annuities are of the variable sort.
Myth No. 3: Annuities Offer Lower Returns Than Stock Mutual Funds
The returns on an annuity depend on how much risk you structure into it.
The more risk you structure into the annuity, the more the earnings will mimic those in the stock market, both on the upside and on the downside in terms of possible losses.
It’s a trade-off. Fixed annuities are stodgy – slow and steady. FIAs may cap earnings so that you won’t get the full upside, but they also set a floor for earnings so you can’t suffer losses.
If security means more to you than the potential of higher returns, a fixed indexed annuity is likely a better bet.
The way we can look at it, fixed annuities have neither the full growth potential of stock funds nor the downside risk. They’re all about safety and giving you a reasonable guaranteed return.
CDs and bonds are a more appropriate yardstick to compare annuities against. And in that scenario, fixed annuities in particular fare quite well.
Many conservative clients will invest in bank CDs offering interest rates around 2.5 percent, while a similarly safe fixed-rate, multi-year annuity often provides much higher interest.
If you’re scared away from annuities, you’re missing out on an opportunity to buy a five-year, fixed-rate annuity that offers fixed interest just like a CD, but on the annuity, the interest is about four percent on the highest, five-year rate.
That’s four percent interest annually. And if they’re letting it grow and compound, they don’t have to file with the IRS, so it’s tax-deferred, not reportable until it’s withdrawn.
It’s a significant benefit. And people would never know that if they’re not open to considering an annuity.
In short, educate yourself, so that you know what you’re getting into and are selecting the right type of annuity to achieve the earnings you’re seeking.
Myth No. 4: Early Surrender Charges Make Annuities Unattractive
Most annuities do have what’s known as surrender periods, and early withdrawal does result in a penalty. Bank CDs also have early withdrawal penalties.
Many financial advisers say such rules surrounding annuities shouldn’t detract from their many benefits. Rather, it’s something to keep in mind when considering whether an annuity is right for you and what type of annuity to sign up for.
An annuity is meant for the money you won’t need for a while. If you’re concerned about the length of the surrender period, look for an annuity with a shorter period.
If you do find yourself unexpectedly needing the money during the surrender period, there are a couple of options. Among them is taking a partial withdrawal, typically up to 10 percent of the accumulation value each year, without penalty.
The withdrawal of earnings, however, counts as taxable income.
Yet another option is to annuitize the contract. In other words, turn it into a stream of income, without penalty.
Overlooked Annuity Benefits
While some criticisms of annuities are valid, many of the detractors fail to mention the benefits annuities provide.
For instance, annuities can guarantee that the payee receives an income for life. No matter how long they live, they will receive their money, notes Barr.
There are also annuities that allow 10 to 15 percent access each year if needed. And if the annuitant happens to go into a nursing home, the company waives the surrender fee to access the funds.
The death benefits associated with annuities are also worth keeping in mind,.
In the event of the death of the annuity owner, beneficiaries on a variable annuity will never receive less than the sum of any withdrawals and the original investment, even if the value of the annuity has experienced a loss.
I have personally experienced situations where an annuity owner died as the markets tanked and the death benefit paid to the beneficiaries far exceeded the diminished value of the annuity.
Of course, there are reasons annuities have a bad reputation. Some annuity products can be complicated, and costly, and their basic transfer-of-risk approach won’t make sense for everyone. But if you shop around and compare options, they can be an extremely powerful retirement tool – so it makes no sense to dismiss them out of hand.
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We have some related articles about what are annuities, what is a GRAT trust, the typical annuity fees, and some myths about annuities that we want to clarify.
I am David, economist, originally from Britain, and studied in Germany and Canada. I am now living in the United States. I have a house in Ontario, but I actually never go. I wrote some books about sovereign debt, and mortgage loans. I am currently retired and dedicate most of my time to fishing. There were many topics in personal finances that have currently changed and other that I have never published before. So now in Business Finance, I found the opportunity to do so. Please let me know in the comments section which are your thoughts. Thank you and have a happy reading.
