Ever considered an an annuity? What features would make you sign on the dotted line? In my experience, you might be offered any of the following:
- Guaranteed rate of return – the return you earn on your initial investment
- Guaranteed principal – you never lose your initial investment
- Guaranteed payouts – a guaranteed income over the remainder of your life
- greater than what a Certificate of Deposit pays.
In an uncertain financial world, it’s understandable that you would be attracted to an investment with these guarantees. If you are considering an annuity, I suggest that you ask these questions before committing. First, — when do those guarantees apply?
Annuities have two principal phases – accumulation and the distribution.
Typically the guaranteed rate of return applies to the accumulation phase only. You might think the guaranteed rate of return is a simple calculation applied to your initial investment. It’s often not that simple. Various fees may apply such as:
- Surrender fees – one to seven percent of all funds,
- Premium tax – in California .5 – 2.35 percent of all funds,
- Investment sub-account annual fees – .2-2.0 percent of all funds,
- Mortality expense – approximately 1.5 percent annually of all funds,
- Cost of rider for guarantee – approximately .5 – 1.5 percent annually,
- Maintenance fee – $50 annually,
- Administration – .15 percent annually of all funds.
The initial investment may be indexed by a specific percent, minus the fees described above.
The rate may be guaranteed, but only if you perform certain time-sensitive actions. In one annuity proposal the benefit was only protected if the annuity owner remembered each year to make a request within a 60 day period once a year, to an unidentified place. It sounded unlikely to happen or difficult at the very least.
The bottom line – yes, you may have a guaranteed rate of return, but when you fully understand what is being guaranteed, it may to be quite a bit less than what you expected.
When you hear “guarantee of principal” you may think, “I can’t lose my principal.” But it’s important to read the contract closely to determine when the principal is guaranteed or what you need to do to protect that guarantee. For example, there may be limitations, such as the guarantee may apply only to one point in time, i.e. the 10th or 20th anniversary date of the initial purchase.
Your principal is protected as long as you don’t take more than one withdrawal, making it a VERY illiquid investment. That’s not to say that all variable annuities are bad investments. I have reviewed a number of annuities within the last year. After expenses, I saw a wide range of returns, some of which were very favorable. In Part Two of this ezine I will discuss some of the more attractive annuities I have seen.
Want clear, unbiased analysis and advice when considering an annuity? Hire an independent hourly financial planner, preferably with a CFP® designation, who can provide comprehensive financial planning.
Disclaimer: There are many variable annuity contracts available through many insurance companies. I have only discussed variable annuities owned my clients and provided to me to analyze.