Annuity Awareness Month

Amanda Clouser, CFA

June is annuity awareness month.

First: Yawn; We’ll discuss variable annuities today; but the only people genuinely excited about this product are insurance salespeople.  

A variable annuity is an insurance product that allows the holder to invest their premium payments (deposits) into sub-accounts, like mutual funds. Most annuities offer death benefits while some variable annuities offer guaranteed withdraw benefits. The one thing more tedious than discussing annuities is reading through an annuity contract prospectus! If you are considering one of these products be certain you read and understand all the fine print. Start with a basic introduction to the topic of annuities

Second: Eyeroll; we would applaud if June was a month dedicated to educating individuals on strategies for creating income in retirement and a discussion of the various choices. Instead this month is dedicated to highlighting a single product, that is often a terrible choice. You’ll likely see tons of articles (read: advertisements) about the benefits of annuities; often sponsored by insurance companies. June will be time to sell, sell, sell as many crummy annuities as possible.

Here’s our take: There may be times when an annuity serves a purpose in your long-term financial plan. Not all annuities are bad, but it’s very important to understand exactly what you own.

The OK

Some variable annuities can create a guaranteed source of income to supplement social security or private pension payments. The guarantee adds comfort to those worried about running out of money in retirement.

If you plan a variable annuity purchase; seek out the low-cost annuity providers, such as Vanguard or Fidelity.

Better yet, work with a Fee-Only Fiduciary Advisor to develop your financial plan! A Fiduciary Advisor can help determine if an annuity is the best way to achieve your goals.

The Bad

Taxation. The income portion of annuity guaranteed payments are taxed as normal income. There is no opportunity for capital gains rates.

Also, you may pass down balances remaining in Variable Annuities but, unlike stocks, your heirs will not get a step up in tax basis on inheritance of an annuity. Further, your heirs pay tax at their normal rates for any gains within the variable annuity.

The Ugly

Most annuities are sold by insurance brokers who collect a commission, creating a potential conflict of interest.

Additionally, you're also likely to face a prohibitive surrender charge for pulling money out of an annuity within the first several years after you buy it. If you need any of your account value within that surrender period, you can expect to give up about 7% of the account value on average. The surrender charge declines by one percentage point a year until it gets to zero after year seven or eight, on average.

Variable annuities also have high annual expenses. The annual insurance charge can run 1.25% or more; annual investment management fees, from 0.5% to more than 2%; and fees for various insurance riders, which can add another 0.6% or more.

Added up, you can pay 2% to 3% or more a year. That could take a huge bite out of your retirement nest egg. Compared to a high quality DFA mutual fund or a Vanguard index fund charging an average fee of 0.30%; the annuity is 10 times more expensive! Alternatively, you could work with a fee-only advisor for around 1% annually to manage investments and devise an income strategy on your behalf for half the cost.

RCS Financial Planning is celebrating annuity awareness month by offering free evaluations of your annuity contracts. Simply provide your annuity statement, and policy contract and we will provide you with a summary of:

·       How much you have contributed (your cost basis)

·       The amount and timeline of the surrender charges

·       The tax impact if you decide to surrender

·       How long you would have to live to breakeven (recoup your premium payment)