The Dark Side of Annuities

Annuities are a popular sales product of commissioned salespeople in the insurance and investment world.  Ask someone about an annuity they purchased and 9 out of 10 times they will say it was sold to them, not “I bought” or “I chose” an annuity.  Many offer promises of guaranteed rates of return, income for life and tax avoidance.  But those promises only work if you follow the rules of one of the most complex investment products on the market and many salespeople don’t even know the rules of their own annuity, which calls for extra caution when choosing one. 

Annuities come with contracts that are so long that virtually no one actually reads them in their entirety.  Consequently, most people who purchase them do not fully understand what they’re buying.  That’s dangerous because if an annuity turns out not to be what you expected (as they frequently do), surrender charges and tax consequences can make them very costly and difficult to get out of.

Four things to think about before buying an annuity

1.  They may not provide enough income to meet your needs.  Annuities can be based on interest rates, which are low right now.  But even when rates are higher, you may need more investment gain than an annuity will actually provide to keep up with your lifestyle or inflation.

2.  The costs can outweigh the benefits.  Most advisors who don't sell annuities will tell you there are times and places when a low-cost, immediate annuity has its place.  But for the accumulation of assets, there are usually too many costs to make them as beneficial as other products.  This is especially true if you are buying from an advisor who is not a fiduciary, in which case you're likely paying a high commission you don’t know about; as much as 10%. 

3.  Few annuity investors actually receive the rate of return they expect. This is often because they haven’t complied with some term or condition they didn’t even know existed.  For instance, some annuities guarantee a certain rate of return, but only as long as you don’t withdraw more than one percent of the account value per year.  Unfortunately, many who find themselves in this situation call their advisor to ask about it, only to learn that he or she didn’t know about it either.

4.  Annuities may be “guaranteed,” but they are not totally risk-free investments.  They are not insured by the government or by the institution, so your payout is only as safe as the company you purchase it from.

Annuities do have their place in some portfolios, but their complexity calls for due diligence in determining whether they are right for you, and if so, what kind of annuity is best for your needs.  If you have any doubts or questions about whether an annuity will do what you want it to do for you, it’s well worth it to consult a fiduciary investment advisor who can help you understand what you’re getting into.