Many financial planners have a love-hate relationship with annuities - mostly hate. Over the years, this type of investment has gained a bad reputation and if you ask us, they’ve earned it.
If you’re planning for retirement or making adjustments to your personal retirement plan, you may be considering purchasing an annuity. In this post, we explain how annuities are like bad relationships - and why you should avoid them.
Annuities Are Like Long-Term Relationships
Buying an annuity is like entering into a long-term relationship with an insurance company. You sign a contract, pay a lump sum to the insurance company, and in return, they repay you slowly over time. The selling point of this partnership is having a guaranteed monthly income stream, typically for the rest of your life.
Depending on the annuity, the insurance company may keep the balance if you die before recouping your full initial investment. Other times, your family members can become beneficiaries of the income after your death - but you have to pay extra for that.
While annuities help eliminate the risk of loss in the stock market or of depleting your savings within your lifetime, this relationship often leaves buyers with a bad taste. Here are a few reasons why this investment isn’t always the best choice for retirees or those planning for retirement.
They’re Not Always Easy to Understand
We all struggle to understand our partner sometimes - to know their deepest wants, needs, and desires. You could even say romantic relationships are one of the universe’s greatest mysteries! But while misunderstandings in love are often unintentional (not to mention a natural part of being human) annuities often feel as if they’re designed to cause confusion.
Like a partner who is passive-aggressive or doesn’t say what they really mean, annuity contracts are loaded with complex terminology and hidden consequences. Annuities come in several different formats, each with its own set of complicated tax rules and fees.
- Variable vs. Fixed period
- Single vs Multiple premiums
- Immediate vs Deferred payments
Before purchasing an annuity or any other type of financial product, make sure you understand the terms. Consider talking with a fiduciary financial advisor, such as a Certified Financial Planner, to help you make an informed decision.
There May Be a Conflict of Interest
As financial advisors, we see it all too often--the person selling you the annuity has a stake in the matter. Like someone who gets into relationships or marries solely for the money, annuities are often sold by pushy salespeople who stand to gain something from the transaction.
Most annuities pay relatively high commissions to the seller - as much as 7% - 10% of the total amount. This, unfortunately, means that some brokers will recommend an annuity to their clients, regardless of whether it’s a good fit or not.
As with romantic relationships, your relationship with your financial advisor should be built on trust and good intentions. But unfortunately, sometimes, in both love and money matters, we don’t find out the truth until it’s too late.
The only way to be sure you’re receiving objective financial advice is to work with a fiduciary. Fiduciary financial advisors are legally obligated to act in your best interest and do not receive commissions in exchange for their services. When developing your retirement investment plan or choosing an advisor to help you select financial products, make sure you understand the different types of fee-structures for financial advisors.
There Are Lots of Hidden Costs
Falling in love is a wonderful feeling and good relationships come with many positive benefits. Oftentimes, the joyful feeling of new love blinds us to the inevitable downsides.
When starting a new relationship, you don’t think about the twenty pounds you might gain from date night dinners and lazy evenings on the couch. You’re blissfully ignorant to the closet space you’ll have to sacrifice or future haggling over the tv remote.
Annuities come with their own set of hidden costs which salespeople may try to conceal or downplay.
Your best bet when purchasing any financial product is to inform yourself and ask strategic questions. If you’re considering purchasing an annuity as part of your retirement investment plan, be sure to look out for hidden charges such as:
- Mortality and expense fee
- Rider charges
- Management fees
- Commissions
Getting Out of One Is Expensive
Just like a bad relationship that ends in divorce, getting out of an annuity contract can be a messy - and expensive - prospect. Most annuities come with a limit on how much you can access during the first several years, referred to as the “surrender charge period”.
A typical surrender period is seven years, with withdrawal penalties of around 7%. This means if your circumstances change and you need the money sooner than anticipated, you’ll face a hefty fee for withdrawing the funds.
When it comes to retirement planning, you’ll need to decide what’s most important to you. For many of our clients, flexibility and transparency are as important as the payout of a particular financial investment, if not more.
The right wealth advisor will evaluate both your financial and personal goals to help you come up with a plan that fits your needs.
Partner With a Financial Advisor You Can Trust
As we all know, trust is the foundation of any good relationship - and planning for financial stability in your retirement years is no exception. Your best bet for finding a financial advisor you can trust is to make sure they adhere to the highest ethical standards. That means choosing an advisor who:
- Is a fiduciary
- Is transparent about any and all fees
- Does not work on commission
- Considers your financial and personal goals to create a customized financial plan
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