My internal alarm goes off automatically whenever someone tells me that their adviser has recommended moving all their money into annuities. Don't get me wrong, there is a place for annuities in some portfolios, and when annuities are the perfect fit, go for it. The problem anymore is that annuities seem to be the perfect fit for almost everyone. It does not seem to matter how old you are, how you feel about risk, what your need for income is or your tax situation. Annuities are a favorite with many advisers and they will find one that fits just right for you. But are annuities right for everybody?
I have worked in financial services for many years and was fully licensed in variable, life and health insurance as well as securities. I saw circumstances when annuities played a role in a comprehensive strategy to assure guaranteed income in retirement. But now I am hearing about people putting all of their money in annuities, even their IRA's, so I am wondering when did annuities became a one size fits all product?
I cringe when I hear someone say that they bought an annuity to protect their savings from market declines. I know that annuities are marketed on the basis of various guarantees or riders that offer the buyer security. I have tried my best to read and understand these complex insurance contracts and I often have a hard time understanding the guarantees, so how can a buyer understand them? What makes matters worse is that as often as I ask these folks if they really understand the guarantee, I also ask if they understand what they were paying for and how much they are paying. So far I have not found one person who could actually explain the product they bought or the fees. Not a good sign.
Probably the most frequently misunderstood guarantee in variable annuities these days is the "living benefit" rider affectionately known as GLWB or guaranteed lifetime withdrawal benefit. If you have one of these, here is how it works.
You buy a variable annuity with this rider for 100,000. The insurance company will guarantee you a minimum annual income of 5 percent of the amount invested or $5,000 per year for life. Now let us say that something like last year happens and now you have $50,000 in your annuity. The rider is on the income, not the value of the principal so you still get your $5,000 per year.
Now let's say things are getting better and that same annuity is now worth $200,000. Your 5 percent income rider would increase your income now to $10,000.
So what's the catch? It is important that you understand that only your income is guaranteed, not your balance. If you wanted to cash out this annuity when the market was in decline and your value was $50,000, even though at one point your account went up to $200,000 and you had a sure thing 5 percent on that income, the surrender value would be the $50,000 less fees and charges to cash in early. These charges can be a real zinger too, so check your policy. Most are a sliding scale with the highest in the early years and decreasing until they go to zero. A good example is a 7-year maturity annuity that would typically have a 6-percent surrender charge if you want your money back that first year. That is more than the income your rider guaranteed. Bye, bye.
Other popular guarantees or riders that come with variable annuities are often just as confusing as the one mentioned above. Some annuities guarantee growth rates of say 5-7 percent per year. But that percentage is typically applied to a hypothetical account value that you can annuitize (turn into a series of guaranteed payments for a certain period of time). Meanwhile your actual account value is based on performance of the investments chosen, not this guaranteed growth rate. So if the market melts down again and reduces your actual account value and you want to withdraw your money, guess what? You get the meltdown value, not the hypothetical account value.
Finally, you need to understand there is no free lunch here. Annuities have fees and all those riders have fees and then there is the mortality and expense fees. The administration fees or perhaps the withdrawal fees or miscellaneous other fees. Suddenly you find out that you have racked up a fee tab upwards of 3 percent or more annually. If you are paying 3 percent of the balance in fees and the insurance company is paying 5 percent in guaranteed income, it becomes difficult for your account to actually grow and keep pace with inflation.
I know it sounds like I am down on annuities. I am not, well not totally. I am down on advisors who sell annuities to their clients when there may be more appropriate products. Your annuity needs to be suitable to your needs, not your advisor's needs. All I am saying is check out the annuity that you are considering. Given how complicated annuities can be, you may want to consult with someone who does not have a commission riding on your decision, such as your accountant or your tax attorney. They will most likely inform you before you make your decision of that pesky premium tax of 3.5 percent on annuitized policies in Nevada.
Good luck, it is really a jungle out there and you need to be an informed and educated investor. The days of trust without question unfortunately are gone, I am sorry to say. Those were the good old days. But, honestly, there have always been people out there willing to misinform you in order to make a sale.
• Carol Perry has been a resident of Northern Nevada since 1983. She was a licensed investment advisor with her own firm before retiring for health reasons in 2008. Carol Perry is not affiliated with AWA Wealth Management in Carson City.