Why I Still Don't Like Annuities

When I first wrote about my general dislike of annuities in 2015 I received lots of phone calls……from other financial advisors!  Their telephone messages and commentary ranged from “What do you think you are doing?” to “Are you crazy?” My answers were “putting the needs of my clients first” and “no, I don’t think so.” Maybe I should start again at the beginning. I do not like annuities. There I said it. Can this really be true? Yes, but it is probably best to clarify by stating that I find some types of annuities acceptable if they are used appropriately within a broader plan to safely allocate risk across the total of retirement assets available to a client.  For clients at or nearing retirement age, annuities can offer a range of benefits including asset protection, tax deferral, diversification and risk management. I find objection when the annuity proposed is not suitable to the client and his/her needs or it is intended to replace rather than to diversify a well-conceived retirement asset allocation plan. As defined, an annuity is a “contractual investment product sold by financial institutions (often insurance companies) that is designed to receive and grow your invested funds and, provide payments (larger or smaller) impacted by how investments in an underlying or separate account perform.”  If only annuity contracts were that clear and easy to understand. In fact, some annuity contracts are so complex, that it is impossible for the client to have a full understanding of the associated real benefits and risks. Please follow my rule of thumb, which is “If I cannot explain a particular investment or strategy (or annuity contract) in two sentences, then it probably is not right for you.”

As a registered investment advisor (RIA), I strive to provide investment advice and services that are strategically aligned with you and your investing needs. In contrast, an annuity is a product which suggests an off-the-shelf readiness to fit the needs of all, but, not necessarily you.  The urgency is on completing the sale, rather than learning what your real investing and planning needs may be. This may be why some annuity purchasers say the purchase of an annuity often feels like the end of the business relationship with an advisor, rather than the beginning. In contrast, as an RIA I work hard to earn your business every month, quarter and year. So why do annuity salespersons often lead with the hard sell? Primarily because annuity sales commissions can reach as high as 10%, particularly in the case of variable and equity indexed products (with attached benefit riders) or contracts with longer early surrender charge periods. Annuity complexity and sales commissions are directly related in that as complexity increases so do sales commissions.

As investment products, annuities carry a certain level of liquidity risk in that the proceeds from the annuity may not be available when you need them. A primary source of this illiquidity are the early surrender charges included in most annuity contracts. Reaching as high as 15%, these charges typically decline in accordance with a specific timetable. As with a 401(k) or IRA, early withdrawals (before the age of 59 ½) will incur a 10% early withdrawal penalty from the IRS. Annuitants (persons receiving the stream of payments) must begin taking required minimum distributions (RMDs) at age 72, with the understanding that failure to do so could mean that the amount not withdrawn could be subject to taxation at a rate of 50%. In some cases, annuities can be a suitable option for investors who want to pay upfront for the right to receive a steady stream of income in retirement. Do your research, ask questions, contract only with top notch rated insurers and avoid proposals that sound too good to be true. If you do not understand the contract, don’t sign it! Try to maintain a focus on the investment viability of the proposed contract. Limit the number of benefit riders as they add both to contract cost and complexity.