If you’re at least 55 years old, you’ve likely seen advertising for annuities. Annuities are a type of insurance that offer some type of guarantee backed by the insurance company. They are often sold as if they’re an investment, even though annuities are actually a type of life insurance. Often, an annuity is sold to give a guarantee of investment principle, income, or rate of return among others. These all sound great, until you peel back the layers of how an annuity works.
Why are annuities a bad investment?
There are 2 parties that benefit from an annuity:
- The Insurance Company
- The Financial Advisor or Insurance Agent selling the Annuity
They benefit all at the client’s expense. The insurance company benefits by getting the upside that the client is leaving on the table. Moreover, insurance companies are able to do that by mitigating the risk of whatever the guarantee. This is done by taking a longer-term view using investment strategies. In addition, these often include bonds and options to hedge the risk.
For an agent selling annuities, commissions can be around 7%. And, if you have ever wondered why annuities are pushed on people, these higher annuity commissions are a big reason. However, compare that to your average fee-only financial advisor. They typically have fees around 1% annually.
Types of Annuities
There are 3 main types of annuities being sold on the market today. These general kinds of annuities are Fixed, Indexed, and Variable.
Fixed Annuities
Annuities that are fixed are like a CD at the bank. They aren’t that popular right now because interest rates are so low. They offer a fixed rate of return usually only a small percentage. Furthermore, this option locks up you money for a number of years.
Indexed Annuities
Indexed annuities are the most popular right now. This is because the regulations on them aren’t as strict as variable annuities. In addition, it only requires a life insurance license to sell. They offer participation to the upside based on a stock index (hence “Indexed” annuity) like the S&P 500 and guarantee investment principle. There are a few problems with Indexed Annuities:
- Money is locked up for many years. 7+ years is the average time before you can take the money out. This is called a Surrender Period.
- If you ever want to take more than 10% of the money out, you have to pay penalties. These are called Surrender Charges.
- There are caps on the index returns. In addition, there can be fees called “spreads.”
- Many times indexed annuities are sold on the premise that the money will grow at the pace of the stock market. This is a big misrepresentation of reality. On top of that, they can be sold as “No Fee” investments. They’re insurance, not an investment. As a result, the fees are the cap, spread or mortality/expense fee within the contract.
Variable Annuities
In the past 10 years, regulators have hit Variable Annuities hard. Additionally, sales have slowly gone down in this part of the annuity world. Variable annuities fluctuate fully up and down with the underlying investment, which is often a mutual fund. The issue with variable annuities are the high hidden fees. These fees can add up to over 3% annually, including the mortality and expense fee, rider fees for income, death benefit, along with the fund expense ratio.
Fees on Annuities
Fees come in many forms and eat away at the return investors can be making. And annuities cover it all when it comes to types of fees. The easiest thing to do would be to stay away. With an optimized investment strategy, you can accomplish anything that could be done with an annuity.
Contact Client Focused Financial today to start investing your money strategically: (609) 439-1687