Annuities have long had a bad rap.
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, begins Ken Nuss, CEO of AnnuityAdvantage, an online annuity marketplace.
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 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 continues 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,” Nuss says. “But some annuities are a perfect solution for some people because they do things no other financial product can.”
Matthew Barr, a life insurance agent licenses in 16 states, echoes Nuss’ sentiments. Marketing campaigns, says Barr, have convinced consumers that annuities are all bad.
“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,” he said. “I’m the first to admit there are some bad eggs out there, but if you work with a trusted advisor or agent who helps explain what type of product you have… annuities can do a lot of good and have for my clients for many years.”
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, explained Nuss.
The simplest type of fixed annuity is the multi-year guaranteed annuity. It’s the annuity that’s 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, said Nuss.
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,” said Nuss. “Keep your eyes open and ask questions.”
And perhaps the even bigger take-away 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, says Peter Quince, who writes professional education classes for At Your Pace Online.
“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,” Quince explained. “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 Nuss looks 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,” he says.
CDs and bonds are a more appropriate yardstick to compare annuities against, Nuss adds. And in that scenario, fixed annuities in particular fare quite well.
Many of Nuss’s 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,” Nuss explained. “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,” Nuss adds. “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 money you won’t need for a while,” Nuss explained. “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’s 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,” Barr adds.
The death benefits associated with annuities are also worth keeping in mind, says Cliff Caplan of Neponset Valley Financial Partners in Norwood, Mass.
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,” said Caplan.
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.