Every Negative Comment About Annuities You ve Ever Heard and Informed Answers So You Can Know the Truth by Karlan Tucker 1. Annuities are all the same. Actually, there are four kinds of annuities. Immediate annuities offer limited growth providing incomes for specified periods of time, including for life. If you choose the life option, even when you have depleted the entire amount you put in, you still will receive income for as long as you live. The income begins 30 days after purchasing the annuity with a lump sum. Immediate annuities have no fees. Variable annuities, like the name suggests, vary in value. You can lose principal in a variable annuity. These annuities offer subaccounts that act like mutual funds. They are tax-deferred and have the highest fees of any kind of annuity, typically ranging from 2-5% annually. To replace lost principal you can buy riders that will replace the principal over time through income paid out over time. Surrender charges typically last for 7-10 years. Fixed annuities have no market risk and offer guaranteed returns, which typically range from 2-5% annually. The length of time you need to remain in the annuity to avoid early withdrawal charges (known as surrender charges) is typically 3-10 years. Fixed annuities have no fees. Fixed indexed annuities are also known as equity indexed annuities. These annuities guarantee principal to be safe and link your returns to indexes like the S&P 500 and the Dow Jones or to foreign indexes like the Euro Stoxx 50. They offer the best of two worlds: safety and opportunity on the same dollar at the same time. The surrender charge period ranges from 5-16 years. Fixed indexed annuities (FIAs) have no fees unless you add on an optional income rider. These riders fees range from 0%-1% annually. Income riders guarantee growth in separate income accounts, growing typically at about 6-8% compounded annually for the purpose of creating larger income payouts over time. 2. Annuities have high fees. Variable annuities annual fees typically range from 2-5%. Immediate, fixed and fixed indexed annuities have no fees unless you add an income rider. Then the range of fees for this option is from 0% to 1% annually. The insurance company makes their money by investing your money and earning a gross yield. Then they keep a spread to cover their expenses, profits and return to shareholders. The net yield is distributed to annuity owners. Fees have the effect of reducing principal when there is no growth. A spread cannot reduce principal. 3. Annuities have little liquidity. Immediate annuities create income within 30 days of purchase, which means you have liquidity within the first 30 days.
Variable annuities typically offer 5-10% annual withdrawals without penalty Fixed and fixed indexed annuities offer 10% annual penalty-free withdrawals after the first year. This means you could spend the entire principal in about ten years without penalty. Bonus annuities that fully credit a 10% bonus on day one can create 50% liquidity at any time by using the company s bonus to offset liquidity charges. At the end of the term of the annuity, which ranges from 3-16 years, your account is 100% liquid. You may do with it as you please. 4. Annuities pay high commissions. Some annuities pay 100% of the commission up front. The range is typically 1-7%. The agent will receive no further compensation. Today, many annuities provide an option to receive compensation each year the contract is in force, instead of up front. This trail compensation ranges from 0.25% to 1% annually. Most variable annuities pay about 1% annually while fixed annuities that offer this option range from 0.25% to 1% annually. Typically, the total payout is higher if the advisor elects to be compensated over time instead of up front. By comparison, most managed money accounts incur annual fees of 1-2%. 5. Annuities don t offer much growth. Immediate annuities pay an immediate income with a growth calculation imbedded in the monthly payout. Variable annuities buy shares of stocks through the sub-accounts that work like mutual funds. Your opportunity for growth is dependent upon the funds chosen. Market volatility can impact your growth and principal either positively or negatively. Fixed annuities pay a guaranteed declared rate. The range is typically from 2-5% annually. Remember, this is a tax-deferred vehicle, so no 1099s are sent unless you make a withdrawal. Fixed indexed annuities safely link to an index. Many indexes are offered such as the S&P 500, Dow Jones, Hang Seng, Euro Stoxx 50, bond indexes and more. The FIA typically does not credit 100% of the gain in an index, but you also never participate in the down. 0% is the worst you can experience and 20% plus has typically been the best. Common yields are in the 5-10% range. The yield credited in any year depends on the performance of the underlying index and the features and crediting methods of the particular annuity. 6. Indexed annuities don t participate in the dividends of the indexes. This is true, but there is always a tradeoff. If you want the dividends, then you must own shares in the index, which means you own the good and the bad. You participate when the index rises and when it falls. Missing out on the dividends in favor of never experiencing a loss is worth consideration. From 2000 to 2010, the S&P 500, as well as the Dow Jones, experienced 50% losses twice. Dividends during this ten-year period averaged 2% annually in the S&P 500 and 2.5% annually in the Dow Jones. Clearly, you would have been much better off to forgo dividends in favor of downside protection of your principal and gains which is exactly what a fixed indexed annuity offers. 7. Indexed annuities have caps and don t give you all the up of the index. This is true. In an FIA you don t get all the up in most years. You also, however, never get any of the down because in an FIA you don t own any shares of any stocks or indexes. The FIA simply tracks indexes performances
and then uses the annual gain in the indexes to calculate your interest to be credited. Not getting all the up isn t uncommon because diversified portfolios typically don t get all the up either. The losers offset the winners, resulting in a blended or average return, which, according to Dalbar and J.P. Morgan, typically is about 1/3 of the S&P 500 s annual performance. FIAs are capable of crediting comparable or higher returns without risk to your principal or previously credited gains. 8. Indexed annuities can change their caps and rates annually. Yes, they have to be able to adjust the cap or maximum amount you may be credited annually because the yield on the funds under their management changes annually as well. When they have less to spend in participating in an index on your behalf, they have to be able to move the caps lower; and conversely, when the yield on the managed funds rises, it gives them more to work with so in those years caps are raised. We live in a very competitive world, so whenever a company can raise caps to give them an edge over their competition to gain market share, they do exactly that. 9. Annuities are complicated. Annuities are contracts with an insurance company to manage your money for a specified period of time. They are backed by the claimspaying ability of the insurance company. Insurance companies have to keep in reserve 100% of all they guarantee, plus excess reserves that are typically 5-10% more. Since 1913, few insurance companies have failed and no fixed indexed annuity insurance companies have failed. Even in the few instances of an insurance company s failure, most annuity owners have had most of their money returned. Despite the notable failure of AIG, no annuity or life insurance owner lost any money. The safest places to place money are generally considered to be U.S. government bonds, U.S. agency bonds, banks with accounts kept below FDIC limits, and insurance companies. You can take income for life, for a shorter period or not at all by simply withdrawing all your funds at the end of the term of the annuity you chose. Immediate annuities allow you to deposit a lump sum and start receiving income for life within 30 days. Variable annuities are mutual funds in a taxdeferred wrapper with features that can be purchased to replace lost principal and generate lifetime income. Fixed annuities are safe; they offer guaranteed yields of 2-5%; and they can generate lifetime income anytime you choose to begin it. Fixed indexed annuities are safe, since principal and previously credited gains cannot be lost to market volatility. Yields are derived from participation in indexes with common yields being between 5-8%. Yields are tax-deferred and compounded since you never experience a loss. An 8% yield will double your money in nine years. You may take lifetime income within 30 days of purchase, at a later date, or never your choice. 100% of the account value may be withdrawn without penalty at the end of the term you elected. Income payouts can adjust for inflation by a predetermined formula or by linking the payout to the ongoing performance of the indexes again, your choice. 10. Annuities have long, hard-tounderstand prospectuses. Variable annuities have prospectuses that inform the buyer of their fees and risk, including loss of principal. The other three kinds of annuities do not have prospectuses, as they are required only when
principal can be lost. Instead, they typically have a two-page summary and disclosure that tells you what you need to know to make an informed buying decision. 11. Annuitizing is bad and required. Annuitizing is the act of turning your principal into an income stream, typically for life. Immediate annuities automatically do this within 30 days of buying the annuity because the sole purpose of an immediate annuity is to create income. The other three types of annuities do not require you to annuitize ever. Annuitizing is an option that you may choose to exercise or not. Annuitizing sometimes is not recommended because if you choose the life option (which means you will get income for as long as you live, even continuing after the principal is exhausted) and were to die soon after, you would lose the balance of your principal to the insurance company. Choosing Life Plus Period Certain can eliminate this risk. By adding the amount of time it takes to have your principal returned to your heirs, you are assured of collecting at least your principal. For example, life plus 20 means you will collect for a minimum of 20 years which can be calculated to return your principal; but, should you live longer, it will continue to pay for the duration of your life and your spouse s if you elect the joint payout. The life only option is often chosen because it pays a higher monthly income then when adding a period certain. Today s fixed indexed annuities have powerful income riders that grow at 5-7% compounded annual returns, then provide guaranteed income withdrawals of 5-7% yearly of your income account balance. At the same time, you re taking income you continue to own and control your principal which continues to benefit by either fixed returns, a portion of index gains, or a combination of both. This type of annuity has no market risk to principal or your income payout. 12. Annuities income doesn t compensate for inflation. This is not accurate. You have several choices to reduce the risk of inflation. Some annuities offer a choice of growing your payout by a predetermined amount (typically 3%), while others continue to link to the performance of indices which will increase your payout in years when the index increases, thus compensating for inflation. 13. Annuities are taxed at ordinary income rates, not long-term capital gains rates. This is true. Keep in mind that most people once retired don t earn more than $65,000 per couple annually. This means you re in the 15% tax bracket. In this bracket, long-term capital gains are zero. There is no perfect investment, so if you prefer capital gains treatment, you have to place your savings in an investment that has risk and volatility to your principal. With annuities, taxes are deferred. If you wish to eliminate taxes altogether you may wrap your annuity in a Roth IRA. Paying taxes at today s lower rates on the seed instead of paying future tax rates on the crop may be in your best interest. Consult with your CPA to determine what is best in your situation. 14. Don t put IRA money in a taxdeferred annuity because your money is already tax-deferred. It s true: with qualified funds, you already are enjoying tax deferral. However, before you put your hard-earned money anywhere, you also want to know four additional things beyond just the tax treatment. Is my money safe?
How much growth opportunity is there? How much liquidity will I have? Is this vehicle capable of generating income and if so, is it guaranteed for life and will it adjust for inflation? It would not be wise to decide to include or exclude a particular vehicle or strategy in your portfolio by considering only one aspect of the financial strategy. 15. Annuities penalize withdrawals made prior to age 59 ½. The IRS treats annuities tax deferral similar to your IRA s. Just like with an IRA, if you make a withdrawal prior to age 59 ½, you will pay the IRS a 10% penalty. This penalty is not unique to annuities but instead is applied to all taxdeferred vehicles. In an annuity you may take advantage of a section of the IRS code called 72t or 72q. Both allow for withdrawals prior to age 59 ½ without penalty if you take substantially equal distributions until age 59 ½ or for five years, whichever is greater. 16. Annuity advisors are unregulated. Annuity advisors must have an insurance license when offering immediate, fixed or fixed indexed annuities and a securities license when offering variable annuities. Variable annuities require a securities license because when you place a person s savings at risk, the vehicle is controlled by the Securities and Exchange Commission and FINRA. Annually, all advisors are required to take continuing education courses to keep their licenses in force. The insurance industry is heavily regulated by each state s division of insurance and the insurance commissioner who is appointed by the governor. Insurance companies enforce compliance and suitability standards on all advisors. Insurance advisors are under the scrutiny of the division of insurance, the state SEC division, and the attorney general s office. It s not uncommon for an advisor to be investigated by all three entities. Subject to review by one or more of these organizations are advisors tax returns, bank accounts, advertising material, office personnel, and clients statements. Many advisors might also participate in the National Ethics Association seven-year background check which is annually updated, as well as the Better Business Bureau ratings, created by their oversight of the particular business. 17. Annuities are seldom used. Approximately $230 billion is placed into annuities annually. Purchases of annuities of all types are expected to grow in light of the tremendous volatility the stock market is experiencing. Many are recognizing the need for both a floor under their principal and the ability to generate sustainable income. Many are looking to annuities as their first source of dependable income and then supplementing their income with less reliable sources such as underfunded pensions and social security. 18. How can I know I won t lose money in an annuity inside an insurance company? In an imperfect world it s not possible to guarantee you ll never have a loss regardless of where you place your money. This means wherever you have your funds now may be at risk due to unforeseen circumstances. Variable annuities do lose money from time to time because they place your principal in the stock market. Losses may occur from market risk, not because there has been a failure of the insurer. The other three types of annuities cannot lose your money to the stock market because your principal is never placed there.
Since 1913, when annuities were first invented, a few insurance companies have failed, although no fixed indexed annuity insurance company has ever failed. When an insurer fails, it is taken into receivership by the state division of insurance. When the process of finding a buyer to take over the assets of the failed company is allowed to take place by the annuity owner, typically most, if not all, contract owners are made whole. AIG is the most notable failure; however, no annuity or life insurance contract owner lost any money in the demise of this company. The reason is there are many safeguards built in to protect policy owners. First is the fact that parent companies are not allowed to take the assets of the insurance subsidiaries an insurance company owns to bail out the mother ship. Second is the quality of the assets the company holds in its portfolio. Insurance companies are very conservative with what they invest in because they are guaranteeing to you they will not lose your money. They place the quality of the investment they make as their highest priority. They employ very skilled people to make these decisions under the scrutiny of management and regulators. Third is the claims-paying ability of the insurance company. This ability comes from a combination of experienced management, the quality of their assets and their profitability. Fourth is re-insurance. Some of the liability to pay claims in many insurance companies is reinsured, including in some cases longevity risk, which is outliving your principal while continuing to receive income from your annuity. Fifth is the guarantee fund each state has that provides protection up to specified limits that vary per state in the event an insurer were to fail. Sixth is the fact that rating agencies such as A.M. Best look at all aspects of an insurer and assign a rating so the general public can be informed as to how well managed any particular insurance company is. 19. Why is there misinformation about annuities? For years leading up to 2011, many brokerage firms and registered reps did not have access to most annuities. Annuities were viewed by many as competition, so it was self-serving for advisors who did not have access to them to speak poorly of them in an effort to retain assets under their management. Because many advisors did not have access or approval by their broker dealer to offer them, they didn t bother spending time to understand how they worked. It was easier to malign them in an effort to keep assets under their control. As a result of the tremendous losses people have suffered in the market in recent years, many of these brokerage firms have changed their views about annuities and are now embracing them. They need access to a vehicle that protects principal, participates in only the up of the indexes and then provides an income that cannot be outlived. Their offering of target-dated mutual funds has not replaced this need. The number of positive articles written about annuities has dramatically increased. Wall Street, however, doesn t change overnight, so the process will be ongoing. Karlan Tucker is Founder of Smarter Retirement Strategies and CEO of Tucker Advisory Group, Inc., a national marketing organization comprised of over 1,000 agents. He has personally helped over 5,000 individuals develop smarter retirement plans over the past 30 years, and recently authored Retirements in Crisis. Karlan and his wife, Angela, reside in Littleton, CO.