Considering an annuity? There’s always a catch
BY TERRY SAVAGE email@example.com April 13, 2011 5:40PM
Updated: May 3, 2013 12:15PM
Q. I am 53 and have $220,000 in a regular IRA earning 1.5 percent. I do not have a company retirement plan. Your thoughts on putting this into a “balanced allocation annuity”?
A. I’m sure you’ve been listening to all those recent radio ads targeted to people who are fed up with earning low interest rates in safe, insured bank CDs and money market funds. But just because you wish you could earn more is no reason to jump for the bait of higher rates. And since the money in your account is already inside an IRA, there is no reason to pay for the tax-deferral annuities offer.
Remember the old Savage Truth: If it’s too good to be true, it’s not true!
I have nothing against the concept of tax-deferred annuities. In fact, I own a few myself, products that have low costs and excellent features and guarantees from highly rated companies. But even so, these investments do not fall into my category of “chicken money” — because they are locked away for a number of years and the money is not readily accessible.
It took me a lot of study, and a respected annuity expert, to overcome my concerns about the hidden wrinkles in these products. I learned that insurers can be very creative marketers!
There is always a “catch” to these promises. Hidden away inside are higher costs, or higher prices, or illiquidity or some fine print that adds to the internal risk. Here are just a few ways that these products may snag you:
†Surrender charges: These fees lock you in for as long as eight years, and sometimes longer. The penalty for taking your money out early can wipe out the benefits of those enticing promises that got you to buy the product in the first place. Those charges cover some of the cost of the high commissions paid to agents to sell these products.
†Annual fees: While an annuity may promise a “balanced” investment portfolio, you are unlikely to match market performance because of the high internal fees associated with the management of the funds. Yes, there are low-cost annuities that use index funds to give stock market performance within the annuity — but then the annuity issuer loses a source of revenue!
†Internal restrictions: Many insurance companies will restrict your choice of investment transfers within the annuity, or even worse make their own decisions on the balance of investments. They follow the market down, selling stock funds and putting you into low-yielding bonds where you can never recoup stock market losses.
†Devil in the details: Many products promise a high rate of compound interest on a “base” — but only if you leave all the money with them and take it out only over your lifetime. Don’t think that you can get 6 or 8 percent annually, or a stock market investment, whichever is better — and then just “walk away” with the money, paying only ordinary income taxes. Uh huh. Too good to be true.
†Equity linkage losses. Market indexed annuities can be the worst offenders. In return for the guarantees on the downside, you are restricted from making the full return of the index on the upside. So either you will get something like 80 percent of the index return, or — even worse — you will get the performance of the index without dividends. Since over the long run, more than 40 percent of the stock market’s total return comes from dividends, you’re fooling yourself.
I checked out the specific annuity you asked about and found it has a 12-year surrender period, as much as 4 percent in annual fees, and that the salesman gets a commission of up to 10 percent of your investment! Also, several years ago, the company settled a class-action lawsuit for deceptive marketing to seniors.
What’s the alternative?
You could move a portion of your IRA money into a diversified stock mutual fund, perhaps an equity income fund or balanced fund through a low-cost fund provider. That will add growth of principal, while your “chicken money” portion in the bank gives you peace of mind.
It’s just that no one offers big commissions for selling that strategy to you. So call Vanguard, Fidelity, T. Rowe Price, American Century, or any of the major no-load mutual fund companies and they’ll show you how to “balance” your portfolio instead of providing a retirement plan for your annuity salesman! And that’s The Savage Truth.
Terry Savage is a registered investment adviser.