Are Annuities a Good Investment?
Key Points in Are Annuities a Good Investment?:
- Are annuities the right tool for the job?
- History of Annuities
- Types of Annuities
- Commissions and Surrender Charges
- 10 minute read | 14 minutes to watch
Dean Barber: Has anybody ever said to you, I’ve got the best investment for you? If that happens, turn around and walk away.
Here’s the deal. Every investment was designed for a specific reason. Before you should ever talk about investments with anybody, they should fully understand your personal situation.
I hope you stick around for this entire video with myself and Jason Newcomer, CFP® and Director of Centralized Financial Planning, as we discuss the question: Are annuities a good investment?
Are Annuities a Good Investment?
Dean Barber: Hello, everybody, I’m Dean Barber, founder, and C EOof Modern Wealth Management, here with Jason Newcomer, and we’re here to answer a question for you that we get asked often. That question is: Are annuities a good investment? Jason?
Are Annuities the Right Tool for the Job?
Jason Newcomer: Yeah, I think that’s a loaded question. It’s kind of like asking someone in construction: Are hammers a good tool? What’s the next question the construction person is going to ask?
Dean Barber: What are you going to use it for?
Jason Newcomer: Right. What are you trying to accomplish here? If you’re trying to get a screw into a board, a hammer is not a good tool.
Dean Barber: But it works.
Jason Newcomer: It might work. Yeah. But there are maybe better tools out there to use.
Make Sure Investments Are the Right Fit Before Buying
Dean Barber: So I think you make a good point. Every single investment product that the financial industry has ever designed was designed for a specific purpose. Right?
The problem comes in when people start trying to put a product into a position or only sell a particular product. So all of a sudden, everybody looks like they’re a candidate for an annuity.
If somebody is selling annuities, then everybody’s a candidate for those annuities because they’re going to convince you one way, shape, or form that will be the right thing.
Jason Newcomer: Right? Yeah, I’d agree with that.
The History of Annuities
Dean Barber: Jason, let’s talk a bit about the history of annuities. When annuities originally came out, it was to allow a person to get what was called an immediate annuity.
You would take dollars, deposit it with an insurance company, and then that insurance company would assume the risk of giving you income for a specified period, and most commonly, it was for life.
They would guarantee you that you would get a certain amount of income based on your deposit for the rest of your life, no matter how long do you live.
Offsetting the Risk of Running Out of Income in Retirement
They did that to take the risk of a person running out of income during their retirement years and shift that risk over to the insurance company. So that was a decent reason for annuities to come into existence.
Jason Newcomer: Yeah, sort of like a pension replacement almost.
Dean Barber: Exactly right. It was for those people that didn’t have pensions, and they didn’t want to assume the risk of something going wrong, and all of a sudden, they’re 75 years old and have no more income.
Jason Newcomer: Right, it started out as a pretty good tool.
Exchanging Principle for Lifetime Income
Dean Barber: That was the original form. But once you put the money in that immediate annuity, and you said, “Give me my first payment.” Then your initial principal is gone. Okay? You can’t ever take it back out. It’s just you exchange that money for a guaranteed lifetime of income.
Then the insurance industry said, “Well if this works, let’s put together a deferred tax annuity.” So they call that a deferred annuity.
An annuity where you could put a lump sum in now defer the ability to take money out until a future date. Some of the earlier versions required you to choose that future date when you put your money in. Then they would guarantee you income at that point for the rest of your life.
Again, another pension replacement. And the neat thing about that was that it would also defer the tax liability until you annuitized it and started getting the income.
Jason Newcomer: It sort of worked like a CD almost with the deferred growth on the annuity with some tax benefits at the back end.
Guaranteed Minimum Interest Rate
Dean Barber: Right. Another neat thing that many older deferred annuities had on them, Jason, was a guaranteed minimum interest rate.
I’ve been in this industry now for 33 years. I can remember when we could put somebody’s money into a deferred annuity paying 7%, 8%, 9%. They guaranteed that regardless of what happened, they would never pay less than 3%. Do you think you can find any of those never less than 3% fixed annuities today?
Jason Newcomer: Yeah, maybe at a strip mall or something like that sometimes. Stay away from those.
Dean Barber: Yeah, they just don’t exist.
Jason Newcomer: No, they don’t.
Dean Barber: They don’t exist. There are people that I know who still have money in those deferred annuities, and they’re guaranteed to get 3%. They’re in retirement years, but that’s their cash, and they can still add to it and take money out of it at will. They’re guaranteed a minimum of 3%. That was a good deal.
Now, along comes the variable annuity. So the variable annuity was designed to allow tax-deferral for people that wanted to invest in mutual funds.
They’re not actually called mutual funds inside of the variable annuities are called sub-accounts.
Jason Newcomer: They work very similarly.
Dean Barber: They do they really work identically to the mutual fund. They’ll mirror what the mutual fund is doing, but it’s a separate account. Even if you buy and sell, all of the earnings and growth are all tax-deferred, just like if it were a big IRA or a 401(k).
You can choose the investment options or hire an investment professional to choose those investment options. It allowed somebody who had large amounts of taxable money that wanted to accumulate and grow that over time and defer the tax liability until they decided to withdraw it.
Jason Newcomer: It is a pretty good idea for someone who’s already maxing out their 401(k) dollars and is in a high-income situation to avoid paying capital gains tax along the way.
Dean Barber: Exactly right, and that works well for those people.
Variable Annuities and Guaranteed Income Benefits
The insurance industry in the late 90s started coming up with these new concepts on the variable annuities of a guaranteed income benefit.
In other words, they would say, “You put $100,000 in, and we’re going to guarantee that an income benefit value will grow by a minimum of 6%, all the way until you reach age 85. That’s the base at which will guarantee your income in the future.”
Then they came up with guaranteed annual withdrawal amounts and all kinds of things. So it got really complicated.
The Dot Com Bubble and Insurance Industry Losses
Then the Dot Com Bubble hit, and insurance companies experienced massive losses. They found themselves on the opposite side, where they were assuming way more risks than what they ever thought was possible.
So they began increasing the prices internally on many of those guaranteed benefits. By the time we rolled into the financial crisis of 2008, a lot of those annuities had internal expenses north of 4%. And that doesn’t make any sense to me.
Variable Annuity Becomes a Four-Letter Word
Jason Newcomer: Yeah, that’s, I think, about the same time that the variable annuity kind of became a four-letter word.
Dean Barber: Yeah, it did. It was like, “Okay, if you’re going to guarantee me 5%, but I have an internal cost of 4.5%. How can I win?
Jason Newcomer: Yeah, the value is just not there.
Dean Barber: It’s just not.
Annuities, Commissions, and Surrender Charges
The other problem, I think, when you ask the question: Is an annuity a good investment? If all you have is a hammer, everything looks like a nail. If all you have is annuities to sell, then obviously, it’s going to work for everybody.
My biggest beef with the insurance industry, and annuities, is that they pay, in many cases, not all, but in many cases, substantial upfront commissions to the financial advisor or salesperson to put the money into annuities. Because they pay that financial advisor a big commission up front, the insurance company then tacks on what they call a surrender charge.
Jason Newcomer: Right.
Dean Barber: Can you explain that?
What Are Surrender Charges?
Jason Newcomer: Surrender charges are basically telling you, you can still access this money, but if you need to touch it, you’re going to pay a penalty. It varies from contract to contract. So, it might be five years, seven years, up to 15 or 20 years, and some of the fixed annuities; if you need to get withdrawals from that account in that period, you’re going to pay a penalty.
Often, in those fixed annuities with 15 or 20 year surrender periods, you may be looking at penalties of 10% to 15%.
Dean Barber: Yeah, some of them are very onerous.
Jason Newcomer: Yeah, absolutely.
Who is Really Benefitting?
Dean Barber: And so that turns me off a lot. It turns you off. And it should turn off the average consumer if they understood what was happening behind the scenes they would say, “Whose interest are you looking out for you?”
Jason Newcomer: You’ve seen those contracts. They’re 100, 200 pages long for an annuity contract.
Dean Barber: With all kinds of very specific rules written by attorneys for the insurance companies to protect who?
Jason Newcomer: The insurance company, right.
Dean Barber: Yeah. Right, because they’re the ones that are at risk.
Fixed Indexed Annuities
Then there were these fixed indexed annuities that came out and were very, very popular. I know many people in our industry today that believe everyone should have a fixed indexed annuity.
Why do they believe that because that’s what they sell, right? Why do they sell them? Big commissions, right.
The problem with the fixed indexed annuities is that the insurance company can actually change the rules in That fixed indexed annuity at any time after the first contract year. You’re locked into it for 8, 10, 15, sometimes 20 years.
Jason Newcomer: Yeah. And in my opinion, you’re giving up too much as the customer for that annuity to make sense.
What Makes Sense About Annuities?
Dean Barber: So would you agree, Jason, that the annuity, the tax-deferred benefits of the annuity, and that the guaranteed income streams of the annuity make sense?
Jason Newcomer: Absolutely. Yeah. Again, it comes down to what are you trying to accomplish? Are you trying to get the highest level of maybe guaranteed income? Maybe an annuity makes sense in that situation.
Are you trying to get tax-deferred growth or special tax treatment on your growth? Again, perhaps an annuity makes sense in that situation.
A Changing Financial Industry
Dean Barber: Now, in the last several years, the financial industry has changed. It hasn’t morphed entirely into what I think it should be or what you think it should be, but it’s changed.
The rise of the independent RIA (Registered Investment Advisor), and the investment advisors that work for those, are working, in most cases, as Accredited Investment Fiduciaries (AIF®). AIF® means that they’re not going to be able to receive a commission.
The insurance industry created a whole new set of annuities, fixed and variable, no fixed indexed yet, that don’t pay the advisor commission. They don’t have any kind of surrender charge to tie a person to that insurance company.
So you can retain that flexibility, and you can have the benefit of the tax deferral, and you can have the benefit of some of the guaranteed income.
What to Look for When Reviewing Annuities
My thing is if somebody is going to look at an annuity, I believe that they really should only look at the annuities that don’t tie you into them and don’t pay whoever is selling you that annuity a commission.
Jason Newcomer: Yeah. Commission-free annuities are really revolutionizing that industry.
Are Annuities a Good Investment?
Dean Barber: So we asked the question, “Are annuities a good investment?” In the right position? Yeah, it is, but it’s not for everybody.
Jason Newcomer: Right.
Dean Barber: We use our Guided Retirement System™ to fully understand what people need and what their money needs to do.
We look at the tax ramifications, the distribution strategies, and the objectives of the individual. If an annuity makes sense, we can search the market for the commission-free, which by the way, have low internal costs as well.
Jason Newcomer: Yeah, a fraction of what you’d find in a traditional commission-based annuity.
It’s Not a Yes or No Question
Dean Barber: So you can’t just give me a yes or no answer on if an annuity is a good investment or not?
Jason Newcomer: If someone walked into my office and asked if annuities are a good investment, I’d tell them I hope you have a couple of hours here because we have many more questions for you before we can answer that.
Dean Barber: Yeah. Well, but that’s the smart way to do it. Right? Fully understand what the money needs to do before you ever make an investment recommendation.
Jason Newcomer: Absolutely, everyone should do that with any investment.
Dean Barber: Well, thank you, Jason, for taking some time today to join us. Ladies and gentlemen, thank you for joining us here on our discussion on the question: Are annuities a good investment?
If you’d like to know whether an annuity is a good investment for you and your personal situation, take some time to visit with a CERTIFIED FINANCIAL PLANNER™.
We’ll take you through our Guided Retirement System™ to determine what your money needs to do. Then we’ll fully explain to you what all the options are. So we can tell you whether an annuity is a good investment for you.
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.