A Note on Annuities: The Drawbacks of the “Wonder Product”
The following is a guest post from Marc C. Shaffer, CFP®, AIF®, EA, of Searcy Financial Services, Inc.
A guaranteed income stream? With the ups and downs of the stock market and employment opportunities over the past few years, many would welcome anything that included the words ‘guaranteed’ and ‘income’ in the same sentence. With annuities being marketed with this promise, it’s no wonder they have earned the reputation of being a “wonder product.” For some people, it may make sense to use an annuity; however, consider these drawbacks before you purchase:
- High Commissions: The commission paid to the annuity salesperson is often in the 6 percent range, and sometimes as high as 8 percent. At a 6 percent commission, for example, the sale of a $200,000 annuity will bring in $12,000 for the sales representative.
- Mortality and expense charges (a.k.a. M&E charges): Annuities have, on average, an annual 1.3 percent charge against the assets plus an annual administration charge for what is termed "mortality and expense charges." (This is in addition to the underlying investment fund charges.)
- Surrender fee: Most contracts have a hefty fee if the contract is surrendered within the first five to ten years and sometimes longer. This is because the insurance company paid a commission to the person who sold the annuity. Generally, the more the salesperson was paid, the longer the surrender term and more punishing the surrender penalty.
- Annuities in IRAs (or qualified accounts): The single most disturbing trend is the annuity sale in IRA accounts. Although annuities may be appropriate for individuals in a higher marginal income tax bracket to accomplish tax deferral, they are usually not appropriate for an IRA investment. Since an IRA is already a tax-deferred vehicle, there is no reason to pay the higher fees charged by the annuity.
Unfortunately, many representatives sell the benefits of annuities without helping clients understand the tradeoff for using this product. For individuals whose situation is ideal for using annuities, they can be a terrific product, but in the wrong situation can be a disaster. With many advisors and agents driven by personal gain, their recommendation may be biased when, in fact, other financial products may make far greater sense. If you are not working with a financial advisor who accepts fiduciary responsibility and can oversee your purchase or explain both the pros and cons to annuities, you may be led to make a decision that is not to your best benefit. When dealing with annuities, the motto is truly, ‘Buyer beware!”
Marc C. Shaffer, CFP®, AIF®, EA, is a principal of Searcy Financial Services, Inc., a registered investment advisory firm in Overland Park, Kan. For more information, visit www.SearcyFinancial.com. Follow us on Twitter at @SearcyFinancial.
*Nothing in this article should be construed as tax advice. Contact a qualified tax professional to discuss any tax matters relating to your retirement plan investment options.
*Guest bloggers sometimes endorse specific investments, general investing strategies or other products/services/ institutions that we do not recommend or have not analyzed. Reviews and endorsements in this post should not be interpreted as a recommendation/endorsement by Smart401k.
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Smart401k is a web-based investment advisory service providing unbiased recommendations to help people invest in employer-sponsored retirement plans. Smart401k provides service to nearly 11,000 clients who collectively have more than $2 billion in assets. Plan participants receive personalized, fund-specific investment recommendations and the support of professional investment advisers available to discuss all investment questions. Based in Overland Park, KS, Smart401k is online at www.Smart401k.com.