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Six Money Mistakes with Annuities

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Another pleasure to have a Twitter friend turn into a real valuable conversation.  Jay Peroni and I share similar beliefs when it comes to money, faith and personal finance!  The subject of annuities have come up as another financial vehicle to be used for financial and retirement planning.  Annuities have often gotten negative press and media coverage so it is my pleasure to have Jay Peroni, Certified Financial Planner, to break through some of the myths and misconceptions people may have about annuities.  Just like any financial vehicle you look to place your hard-earned dollars in, is worth increasing your financial education and knowledge so you can make a better decision for you and your family’s future.

Enter Jay Peroni, CFP:

What mistakes do investors often make when they look at annuities?

Most of the money gurus attack annuities.  For the most part the criticisms are justified. After all, when you look at the fee structure, commission incentives for agents, the often lengthy surrender charges, inflexibility, and the many stories about seniors getting taken advantage of because of improper annuity sales, it’s easy to see why they get such a bad rap. Why do

There are two main types of annuities: fixed and variable. In a fixed annuity, your money grows at a fixed rate usually determined by current interest rates. Another variation of the fixed annuity is an indexed annuity which ties your interest to an index like the S&P500 or Dow Jones.  You usually have a cap (maximum you can earn) and a floor (lowest return you could achieve). A variable annuity, on the other hand, allows investors to participate in mutual fund-like subaccounts. The assets in a subaccount may be allocated across a mix of stocks, bonds and money market funds.

Jay Peroni, CFP is the author of the Faith-Based Millionaire

Let’s look at six of the biggest mistakes investors make when they choose an annuity.

Mistake 1: Underestimating variable annuity fees

In addition to high commissions, variable annuities have high costs compared to many other investments. These expenses essentially guarantee you won’t achieve a reasonable long-term rate of return. It’s like you have a ball and chain!

Here’s a typical expense structure:

Mortality and Expense Charge 1.50%

Sub Account Management Fees 1.00%

Unreported trading costs 0.78%

Annual Administrative Expenses 0.15%


Mistake #2: Tying money up for years

Many annuities (fixed and variable) have surrender periods ranging from 3 years to 15 years or longer.  The typical surrender period is seven years! This means your money is tied up! If you want to sell your annuity, you will pay dearly. For example look at a typical surrender schedule on a 7 year annuity:

Surrender Schedule

Year 1: 8%

Year 2: 7%

Year 3: 6%

Year 4: 5%

Year 5: 4%

Year 6: 3%

Year 7: 2%

This means on a $100,000 investment you may have to pay $2,000 to $8,000 or more to sell your annuity. Talk about inflexible! Yes, most annuities do allow you to withdraw up to 10% per year without penalties, however, you can never completely cash out until the surrender period expires. In the investment world seven years is a long time and things change rapidly. Being stuck in an expensive annuity is not a place you want to remain in limbo.

Mistake # 3: Not reading the fine print

For most investors, annuities are quite complex investments. Between knowing what a subaccount is, how living and/or death benefits work, surrender schedules and fees, withdrawal options, living benefits, how cap rates work, on and on. Fixed and variable annuities are often so complex that even the advisors who sell them truly don’t fully understand what they’re selling. The prospectus that comes with an annuity is often filled with legal jargon galore!

Mistake # 4: Underestimating inflation.

Many investors choose fixed annuities instead of the variable option. In a fixed annuity, your money grows at a fixed rate. At first that kind of financial predictability sounds wonderful, but there are two problems that come with it. One, your rate of return might be meager compared to what you could earn in the stock market. Two, inflation is going to make that fixed return worth less and less with the passing years, unless you pay (possibly through the teeth) to have the rate of return adjusted.

Mistake # 5: Relying on a variable income guarantee

Many variable annuities let you benefit from stock market gains while shielding you against stock market losses. In the past, many have offered the annuity holder at least a minimum rate of return (a GMIB, or Guaranteed Minimum Income Benefit). Many have also offered guarantees that the annuity value will not dip below the value of the initial principal (a GMAB, or Guaranteed Minimum Accumulation Benefit). Be very careful that you understand how these benefits work and what strings are attached.  These benefits often come with a high price tag and require that you follow a ton of rules to take advantage of the benefits.

Mistake # 6:  Thinking an index annuity will perform better than the market

Equity Indexed annuities are not necessarily all they’re cracked up to be. They are a class of fixed annuity that is linked to the performance of a stock market index, commonly the S&P 500. An EIA has a guaranteed minimum rate of return (guaranteed by the insurance company, not the FDIC), and it gives you a chance to capture some of the stock market gains. That’s the upside. (On the whole, EIAs are not designed to beat the stock market; they are basically designed to perform a little bit better than the fixed markets.) Many investors assume they get all of the good side of the markets with none of the bad.  Often I have found that the average return and investor gets with an indexed annuity is more in line with the bond market than the stock market because of the annual caps set by the insurance company issuing the annuity.  For example, the cap may be set at 8 percent and that is the maximum you can earn that year.  The market may be up 20, but you will only earn a maximum of 8.  This cap limits your long-term rate of return.

Jay Peroni, CFP

As you can see, annuities are quite complex and often confusing.  They offer many benefits but you need to fully understand what you’re getting and know the benefits along with the limitations.  Before investing in annuity always get a second opinion and read the fine print carefully.  As with any investment, buyers beware!

More about our guest blogger, Jay Peroni:

Jay Peroni is a Certified Financial Plannerâ„¢ professional, Qualified Kingdom Advisor, blogger at www.jayperoni.com, and President and CEO of Values First Advisors, a firm dedicated to helping individuals and organizations enhance their investments without sacrificing their principles.

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