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| Pathways Advisory Group, Inc. Jeff Karst, Associate Planner  |
Every so often clients ask about annuities. We always review the policy to understand how it works, then discuss the advantages and disadvantages. Most of the time (ok, almost always), the client decides not to purchase the annuity. Why did they consider purchase in the first place? Many times you get invited to a nice dinner to listen to a sales pitch (that usually sounds great).
Annuities come in two basic forms: fixed and variable. (There is a third called Indexed Annuity but I won’t get into that here. Stay tuned for a newsletter article from Dustin about Indexed Annuities.) Each type of annuity can have different riders that add to the “benefit” of the annuity but at an additional cost.
Fixed Annuity
A fixed annuity is called such because it has a fixed interest or payment amount. I think of these as extremely long-term CDs. You get about the same rate as a regular long-term CD. However, there is usually a “teaser” interest rate that resets to the minimum policy interest rate after a few years.
The Sales Pitch: You get a monthly payment for the rest of your life. It’s GUARANTEED to never go down.
The Problem: Inflation will make the payment effectively less each year. An annuity started today will have less than 1/3 of its purchasing power in 30 years. Will your grocery bill be cut in a third over the next thirty years?
Variable Annuity
A variable annuity has underlying investments. Usually you choose between a few different mutual funds that the insurance company provides. Typically you’ll see riders to add a guarantee to the annuity.
The Sales Pitch: Our product will allow you to participate in market returns. If the market goes down, you can purchase a rider to GUARANTEE your income (for a measly .5%).
The Problem: Variable annuities typically have high internal fees, as much as 3%. These high fees are a drag on your performance. That does not include the expense ratio of the underlying mutual funds. The rider guarantee typically adds a fixed income amount (basically turns it into a fixed annuity). The insurance company benefits from these riders because of the long holding period requirement. Annuities can have surrender charges as high as 20% to withdraw your money in the first 10 years.
For some, annuities may be a perfect investment. They don’t mind the high fees and the relative stability gives them peace of mind. Some policies are certainly better than others. My problem is the way they are sold. The advantages are inflated and the disadvantages are mostly ignored, making annuities sound like the perfect investment. Like my Pape always used to say, “If it sounds too good to be true” well, you know the rest.
