As an annuity agent and financial advisor, people assume I gloss over the negative aspects of annuities. As too many other agents do this, it’s a reasonable assumption to make. But once in a while, you will find a good agent who will give you full disclosure and give you the whole truth. Annuities definitely have disadvantages- the downsides of these products will change depending on the type of product chosen.
Annuities in and of themselves are not good or bad- each has certain characteristics that makes them either appropriate or inappropriate for a given individual. And yes, there are some bad annuity companies that I choose not to work with. So, what are the downsides? I’ll go through each product class and explain the primary drawback to each of these. Now, there certainly are situations- MANY situations- where the benefits outweigh the drawbacks, but that is not the subject of this article.
Immediate Annuities offer the highest payout of any income product and are attractive for that reason. The downside: full account value is surrendered to the company in return for lifetime income. That leaves your heirs high and dry. If you live past life expectancy, you win. If you don’t, the company wins. If you pass away sooner than anticipated it can be a really raw deal.
Fixed Annuities are not a short-term cash investment. There is no apples to apples comparison with CDs. Certificates of Deposit are a good place to hold cash for a short period of time. Fixed annuities do have advantages but need only be considered when the surrender schedule fits within your time horizon.
Variable Annuities get slightly more complicated. The fees can get pretty high so investors must consider the value of all the extras that can increase fees to 3% or more. Also, the investment options within variable annuities are fairly limited so you won’t have the same flexibility as with an IRA. Perhaps the most troubling provision sold with variable annuities is the income guarantees. In most cases, higher income and greater market participation are available elsewhere. Also, guaranteed income riders are rarely explained properly so it’s important to find an advisor who knows the contract forward and backward.
Equity Indexed Annuities are even more difficult to interpret. Of the 325 products on the market, I’ll make an educated guess and say that 10% or fewer are actually decent contracts. Participation rates only give an investor a portion of the index return annually and cap rates limit the total possible return. In addition, the contract fees can be as high as those in variable annuities. Many companies make up for the upside market potential with miserably low guaranteed minimum rates or simply a principal guarantee with no growth potential. Tread lightly and do your homework. There’s no other way around it.
Each product class fits the need for a select group of consumers. Suitability must be determined with the help of an advisor who can adequately explain the ins and outs of a contract you are considering. Unfortunately, a lot of agents find a high commission product and work backward instead of gathering a client’s information and working forward to properly address an individual situation.
An annuity may not be what you need or want, but may be what you are being sold. It’s important to work with someone who will help you understand your needs first, and only then figure out how best to satisfy those needs, rather than get sold on a product and shoe-horn it into your situation.