Many financial advisors will suggest that variable annuities are a sound investment for just about any client approaching or in retirement, no matter their situation. Originally designed to provide reliable and steady flow of cash, annuities often seem like a great asset for those who are worried about running out of money in retirement, which includes most Americans today. Dig a little deeper, however, and it quickly becomes apparent that an annuity isn’t always the best solution for retirement planning.
4. Paying for Insurance You Won’t Need
Annuities are, by definition, a type of income insurance, meaning they aren’t really investments. They are complex products sold and backed by large insurance companies that promise to pay an income stream for the life of the annuitant. Many people will tell you this is a great idea because it can give you peace of mind by offering guaranteed income in retirement. This is in principal, but is it true in reality? When you factor in the high insurance and investment fees that are deducted every year from your account value (along with any withdrawals), is it really worth it?
3. High Insurance Fees
Annuities usually have some high insurance fees packed into them, sometimes equal to 2% to 3% each year. These come in the form of “riders” that you select, which are different add-ons such as an automatic yearly increase of, say, 6% to the annual payout for every year that you wait to withdraw from the annuity. If you pick, for example, a lifetime income rider that pays you only until your death, your fees are going to be very different than if you select an income rider that pays until both your spouse and you die. Some of these “living” benefits that you can add on are more risky for the insurance company, since there’s a greater likelihood you’ll claim them. And, since most of an annuity’s fees are buried in lengthy agreements, you may never know exactly how much you’re paying in insurance fees.
2. High Mutual Fund Fees
In addition to high insurance fees, you will find high mutual fund fees in most variable annuities. That’s because they’re more likely to use actively managed mutual funds to invest your money. These mutual funds have higher fees (to pay the people managing the money) than index funds (that are mostly run by computers). They may even be a specific class of higher fee mutual fund that pays out an on-going sales commission to the broker who originally sold the annuity. This is called a trail and can run in the range of .50% to .75%. Perhaps most discouraging, annuities tend to bury their fee structure in lengthy contracts describing complex structures. This combination can make it difficult to find out what you’re really paying or getting.
1. Investment Underperformance
Because variable annuities allow investors to put the principal in actively managed mutual funds, you are also likely paying for investment underperformance. More than 80% of actively managed funds fail to meet their targets. Even if the mutual funds in your annuity perform extraordinarily well and outperform the market, high fees might detract from your returns. If you assume a 6% average growth rate for stock market, then deduct 3% in insurance fees and deduct 1.5% for mutual fund fees that include the broker’s trail, you don’t have much left—and your actual growth rate (burdened with mutual fund and insurance fees) could even be negative during periods of modest stock market growth. So, given the multiple layers of high fees and the complexity of variable annuities, is the insurance company’s guaranteed income really worth it?
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.
Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Guarantees are based on the claims-paying ability of the issuer. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns and principal value of the available subaccount portfolios will fluctuate, so the value of an investor’s unit, when redeemed, may be worth more or less than the original value.