Should I Buy An Annuity

Buying my First Home

I remember back to when Stacy and I were first married and were looking to buy our first home.  It was very tempting to buy an existing house because we were first time buyers and we’d be able to know exactly what we were getting.

However, as we looked at what was on the market, there was always a fundamental flaw with each home (too small, too expensive, wrong neighborhood, too far from work, needs too much work, etc.)

Ultimately, we decided to build a new home in the exact location and with the exact features we wanted.  We were nervous, but in retrospect are really happy we made this decision because we’re still in that same home 20 years later.

Buying an annuity is a lot like buying an existing home.  You know exactly what you’re getting (you give us this amount of money and we’ll send you this amount each month starting on this date); however, it may not be exactly what you need to achieve your long-term financial goals.  Read on below for 7 reasons to look before you leap into these often-overpriced investment products.

Reason #1 – High Costs at the Start

The single biggest reason to stay away from annuities is their high fees.  These are well-disguised by annuity sellers, but believe me, they are there.  This explains why the SEC, the Financial Industry Regulatory Authority (FINRA) and the North American Securities Administration Association (NASAA) have all issued warnings to annuity providers in terms of their sales practices in recent years.

When investors pay higher fees (even as little as 1% higher) on their investments, this can make a huge difference in long-term returns.

Reason #2 – High Costs at the End

Selling an annuity can be a painful experience.  Surrender charges are often significant and can chew through years of your gains.   Taxes are also an issue – the profits you earn will be taxed at your personal income rate rather than at the lower capital gains rate and they do not pass tax-free upon death.

Reason #3 – Overpromising and Underdelivering

Some “indexed” annuity products claim to offer most of the upside of the stock market with downside risk protection.  In reality, annuity sellers restrict annual gains either to a fixed percentage or limiting them to a small percentage of the stock market’s gain.

In addition, many annuity contracts allow the issuer to “change the rules” every year so that what you sign up for may not be what you end up with in terms of your returns.

In this recent Wall Street Journal article, Scott Stolz, president of the insurance and annuity division of Raymond James, is quoted as saying, “While I believe that an indexed annuity can find a place in many conservative investors’ portfolios, I also believe it is a product that is frequently incorrectly sold.”

Reason #4 – Skimpy Returns

The article goes on to say that advisors who truly understand indexed annuity products should portray them as “juiced-up bank certificates of deposit” and are best suited for conservative savers who want to earn, anywhere from 1.5%-3.0% percent more than they can earn on bank CD’s over an intermediate time period – typically 7-10 years.

Reason #5 – The “Hit by a Bus” Factor

If you are trying to provide for your heirs, annuities are a terrible way to do this.  In the most extreme case, you sign the annuity contract, receive a monthly payment or two, then get hit by a bus and your principal is gone forever.   If you want to protect your spouse, you’ll have to accept lower payments, which further lowers your overall returns from these investments.

Reason #6 – What Happens if You Need Your Money Back?

I don’t know about you, but I like being in charge of my money.  Once you hand it over to an annuity provider, it’s often a painful process to get it back if you need it.  At the very least, early withdrawals will likely be subject to surrender charges and, in some cases, annuity providers limit the amount you can withdraw in a single year, even of your own principal.

Reason #7 – No Inflation Adjustment

If you’re still working, think about what your paycheck was 20 years ago.  Would you still be happy receiving this amount today?  I’m guessing not.  Remember that when you’re considering buying a fixed annuity.  They payment may seem pretty decent in today’s terms, but won’t go very far as you get out toward the end of the annuity contract.

Your Assignment

So when you’re asking yourself, “Should I buy an annuity?”  remember that being a long-term investor sometimes isn’t easy, particularly with last year’s subpar returns and the rough start to 2016’s market.  It may be tempting to invest in an annuity and have the certainty of a guaranteed return from your hard-earned investment dollars.

However, this certainty comes at the price of higher fees, low returns and limited access to your money should you need it.  Instead, consider investing in a globally diversified portfolio made up of low cost ETF’s and index funds.  You can make investment changes at any time, you can access your money any time you want it and no one will rewrite the rules on you without you even knowing it!