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4 Big Problems With Annuities Thumbnail

4 Big Problems With Annuities

4 Big Problems With Annuities


COMPLEXITY

All investments come with a document called a prospectus that explains the product, risks, expenses and disclosures that an investor needs to know. Many annuity prospectuses are several hundred pages long and, in some cases, up to 800+ pages long. Plus, supplemental packages that can number several hundred pages themselves. Any investment that requires a thousand pages to articulate risk, expenses and investment parameters, should make an investor think twice.

FEES

Buried in those prospectuses are all the fees you will pay as part of the annuity contract. Administrative fees, Mortality Expenses or M&E, the fees on the underlying investment, contract charges and Riders. When added up, it is not unusual to find that many annuities cost 3.5% or more per year in fees. In a balanced portfolio of 50% stocks and 50% bonds, you it is reasonable to expect a long-term average return of 4% to 5.5%. Depending on the investment mix and the overall fee structure, many annuities are destined to produce little or no return for the investor.

To put this in perspective, a hypothetical $100,000 invested in an annuity with a 3% expense ratio (all in) would be worth $222,258 after 20 years assuming a 7% return per year. That same investment in a portfolio in traditional investments that had a cost of .75% would be worth $347,903. A staggering $125,646 or 57% of the total potential return would have been lost to expenses. 

INCENTIVES

Insurance agents or financial advisors who receive commissions for selling products have a strong incentive to recommend annuities to their clients. These commissions can be as high as 10% of the invested value. For instance, a $100,000 investment would pay the advisor $10,000! That is for a single transaction that might a few hours to complete. Few, if any, other investments pay such extraordinary compensation. As you can imagine, this skewed incentive system leads certain advisors to favor annuities over traditional investments. Ultimately, should you really have to worry about biased advice from an advisor? The answer should be a resounding “NO!”.

TAXES

The scope of different tax issues associated with annuities is extremely broad. That said, they are often presented as tax shelters, which is true. However, it is only partially accurate as annuities allow for deferral but introduce less favorable tax treatment on distribution. Moreover, at death many annuities will pay out in such a way that the investment is heavily taxed. Yet another reason to be wary.

Learn more

If you bought an annuity and have questions, we can help. Click here for more information.


For more information on what annuities are and how they work, click here

LPWM LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers.