Your Awful Annuity Investment

  by Tyler Curtis

by Jesse Anderson, CFA

Are you considering making an investment in an annuity?  Do you truly understand the product and all the guarantees, fees, and expenses?  In discussions with prospective clients looking to change their investment strategies many have been comparing our strategy with annuities.  Even after our conversations, many investors still do not understand the disadvantages of these investments.

According to the 2009 Survey of Owners of Non-Qualified Annuity Contracts by the Gallup Organization the number one reason to make the decision to purchase the annuity was “it was a safe purchase”.  I agree that annuities are a safe purchase, but the cost of safety is too high in my opinion.  In what is considered a lost decade of equity investing, guarantees and safety are appealing to many investors.  But, without fully understanding the fine print and hidden cost in these investments, outcomes can be very different from the performance projections and guarantees.

How much does your annuity really cost?  Depending on the type of annuity, there are different fees that could be associated with the product.  For fixed annuities, the cost is normally in the form of a lower guaranteed rate than current market interest rates.  Although you don’t see a monthly charge or fee listed on your statement, the limited return will cost real dollars in the long run.  For variable annuities the two biggest expenses are Mortality and Expense Charges and Management Fees on the investment choices.  Again, you won’t see these charges deducted from the account.  Instead, they are come in the form of lower performance or just a portfolio value at the top of your statement after all the fees and expenses are deducted.  To find these actual costs, you will need to review your annuity’s prospectus.  It is safe to assume each of these fees is at or above 1% for a total cost over 2%.

The most expensive charge could come in the form of a Surrender Charge.  Most investors think this fee will never apply to them.  This could be true right up until you reach a point where you need the funds.  These fees typically start at between 7-10% and slowly decline each year.  This high cost to access your funds is part of the reason the insurance companies can guarantee returns.  Also, the guaranteed returns are eliminated when you take an early or excess withdrawal.  What most investors don’t realize is they can do equally as well or better if they simply make a long term commitment to their investment strategy and not abandon it if the market drops in the short term.

We recently learned Investing is not for the Faint of Heart, but that does not mean you should pile into these products.  Only a select portion of these products make sense for the extremely risk adverse investor.  And, just because we’ve had a few difficult years in the stock market doesn’t mean you should become risk adverse and run to the nearest “safe” investment.  Finally, I nearly forgot to mention, the 6% commission some of these products pay make them the easy recommendations for anyone who wants to sell a product rather than manage an investment portfolio.

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