Should You Hate Annuities?
If you are reading this article, you can probably identify with the title in some form. However, annuities are one of the largest growing financial segments in the financial industry.
There are currently 223,000 advisors in the financial services industry and only 1% of those advisors produce more than 1 million in production annually. Out of those select few advisors, only a handful of advisors have a radio show that offers financial information on a regular basis to educate their clients and their communities.
If I use this select group of top producing individuals, how many of those advisors do you think offer annuities as a part of their practice for financial services? The number may surprise you. Out of the top advisors in the financial services industry, over 50% use annuities as a part of their practice.
So, if the best and brightest minds in the financial services industry are using annuities with their clients, then why do so many people hate annuities? Why are there so many websites, radio and TV personalities that seem to, on a regular basis, warn against annuities? The old adage “where there is smoke, there is usually fire” would seem to fit.
First of all, there are many cases where annuities are not appropriate for a person’s portfolio. There are also different types of annuities and many misconceptions associated with them.
- If I buy an annuity for income, my children or beneficiaries will receive nothing. Most people only understand annuities up to this point. Benefits can continue for many years or many beneficiaries; they do not stop at death of owner or spouse.
- If I take income, I lose access to my money. Most annuities sold today are deferred annuities. These annuities allow withdrawals, however, these withdrawals may be subject to surrender charges, ordinary taxes, and, if under 59 ½, a 10% tax penalty. An investor can take income but still have access to funds in case of emergencies or unexpected income needs.
- Annuities have poor returns. Some types of annuities have low returns, but many of the most popular annuities in the industry are providing returns that are very comparable to bonds or bond index funds. Typical bond funds produce 6-8% long-term rates. In today’s low interest rate market, that’s a decent or reasonable return for safe or income producing assets.
- Annuities have high commissions. It’s true, some annuities pay high commissions to advisors.
An annuity is a tax product and the IRS has set rules because of the tax basis. For instance, an annuity pays no interest income when interest is earned each year. There is no 1099R or 1099D that is reported, so no tax is due until income is taken. Because of this tax basis, the IRS treats an annuity as a retirement vehicle. As a result, you must use an annuity like an IRA-type vehicle because early distributions prior to age 59 ½ may be subject to early withdrawal penalty of 10% like an IRA. Many times an annuity is not a suitable investment for young people or short-term investment solutions.
The above reasons are why annuities are cast in a negative light, but annuities can play an important role in investing.
The good news: Annuities carry a lot of protection that many investments don’t have.
- An annuity may be creditor proof and liability proof. A mutual fund, bond fund or a stock does not have those protections. A person can declare bankruptcy and an annuity is an exempt asset—where stocks, bonds, mutual funds and cash are not. A person could be found liable and sued but the annuity may not be subject to seizure or levies. A mutual fund, bond fund, stock or cash do not have those protections. A person could have millions of dollars in annuities and all of them may be exempt from seizure by creditors even if found liable or a fault in a suit. However, if you begin taking withdrawals, the withdrawals are subject to levies and judgement collections.
- An annuity can help guarantee principal. A mutual fund, bond fund or a stock does not have those protections. They are subject to market fluctuations and do not have any guarantees.
- An annuity can help guarantee a minimum interest rate. A mutual fund, bond fund or a stock does not have those protections. They are subject to market fluctuations and past performance is no guarantee of future results.
The bottom line is some of the best and brightest advisors in the industry use annuities for their clients, if appropriate. If your advisor has not mentioned some of the benefits of a differed annuity in your portfolio, you may want to ask yourself, “why?”
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