by Josh Stelzer, CFP®
With historic market volatility and the next crisis du jour seemingly looming just ahead, insurance companies are ramping up advertising, and capitalizing on the fears of investors. The laundry list of guarantees and flashy marketing materials can certainly appeal to investors who fear recent market turbulence – but what’s the catch? Let’s take a look at what investors must know when considering the purchase of an annuity.
First and foremost, you must understand that annuities are extremely complex products. Having been an annuity salesman in previous years, I can personally tell you that these products have more moving parts than any investment vehicle available in the market. In fact, annuities are so complex, I’m willing to bet that even your agent hasn’t read through the 150+ page prospectus for each variable annuity product that he or she sells. What’s a prospectus? If you’re seriously considering a variable annuity and don’t know what a prospectus is, you better think twice.
The prospectus outlines the terms and conditions of the annuity being sold and is required by law to be provided to the purchaser of any variable annuity. This is an extremely important document to read before purchasing an annuity, because it outlines the rules surrounding the guarantees that are being offered, as well as all the fees and additional benefits associated with the annuity. Remember, you may be signing a 5+ year contract, so spending a few days to read through the entire prospectus should be a no brainer. You’ll most likely be surprised with what you find in the fine print.
There are really three main areas to focus on when considering an annuity. The fees, surrender charges, and whether or not the agent selling the annuity has your best interests in mind. The first area we will focus on is the fees.
Annuities tend to have some of the highest fees when compared to other investment products. When speaking with an agent or advisor about an annuity purchase, have them write down all the fees associated with the product, and then calculate the total amount for the product being presented. These will typically include mortality and expense charges, administration fees, underlying mutual fund expenses, and any fees for riders attached to the contract. It may be surprising that the total of these fees can very easily be in excess of 3.0% per year, with the potential to rise to over 5% per year in the future. Factor in inflation, and you‘ll need a pretty decent return to simply break even.
Surrender charges are another very important characteristic of annuity products. In short, if you choose to cancel the annuity contract prior to the end of the surrender period, you will be charged a surrender fee that can often times be as high as 7-10% of your account value, depending on the contract. This essentially locks you in to the annuity contract for a set amount of time, typically between 5-15 years, with very little access to your initial deposit amount. These fees often become relevant when the annuity owner encounters an unexpected event, such as a medical procedure, and they are now forced to pay a high fee to access the funds needed. This fee will most likely offset many of the positive “guarantees,” bonuses, or riders that were offered with the initial purchase of the contract.
The third element of an annuity sale may be the most important and controversial, which is the commission paid to the agent who sells you the product. We all know that anytime a commission is paid for selling a product, a conflict of interest is created. Your financial advisor may indeed be very ethical, but the fact is, many of these annuities pay a 3-5% commission to the advisor based on the initial deposit amount. This means that if you buy an annuity for $250,000, your agent may be receiving a $7,500 to $12,500 commission. The concern here is the possibility that your best interests may not be the #1 priority. I would strongly encourage you to ask your agent how much he or she will be making on the sale. This is information that any ethical advisor should have no problem disclosing to you.
As you can see, annuities can be more complex than you may have initially thought. The items discussed above are only a few of the many characteristics to look for in these annuity products. I strongly encourage you to consult with a third party, non-biased professional when considering the purchase of any annuity. Often times, simply knowing the right questions to ask can save you from making a mistake that will impact you for several years to come.
*Please refer to your products prospectus in reference