The Issues With Annuities Part 1

There's a lot of concern regarding the stock market right now. As the Coronavirus has slowed down production lines and factories, as well as the workers in those factories getting ill, the demand for services has come to a standstill. And if you watch commercials on the TV for different investment firms, you can easily get mixed messages on retirement products, especially annuities.

Since annuities are sold my insurance companies I thought I'd throw in my two cents on the matter. First and foremost, I want to say that there are hundreds of different insurance products out there, and each one has a need somewhere. With that said, annuities can be a good fit for some people, but to assume that everyone needs one is completely wrong.

Before I get into the weeds here we need to discuss the types of annuities.

• Fixed annuity - Much like a CD at a bank, they tell what kind of return you can get based on interest rates. You know what you're getting.
• Variable annuity -Sold by financial advisors, it has market risk and is much like a mutual fund. There are riders that can be added through some carriers, and those can cost extra.
• Fixed indexed annuity (FIA) - The most common type of annuity, the growth is based on an "index" of the market, usually based off of the S&P 500, but others are available. There's usually a "cap", which is the maximum return you can earn. The floor is zero, so if the stock market drops, you stay at zero instead of going negative.

Sticking with FIA's for this post, there are some points that need to be discussed.

• In this low interest rate environment, the caps on annuities are low, in the 6-8% range at the time of this post. If someone tells you that they have a 15% cap or higher, be very wary.
• These products are illiquid. Cashing them out can incur penalties and charges from the insurance company. 
• There is a tax penalty of 10% if you use the money before age 59 1/2. 

I knew an agent who would want to put every dime someone had in the bank in an annuity. Why? For the commission, of course! But if you want an annuity, I recommend committing no more than half of your retirement funds.

Let's look at an example using round numbers. Assuming that you are 50 years old and have $100,000 in a CD at the bank, we're going to see how long it takes to double your money as well as your distributions. There actually is a formula that shows how long it takes to double your money given an interest rate. This Rule of 72 says that if our cap is 6%  and the markets do well enough to return that each year, it would take 12 years to double your money to $200k.

At this point you are 62 years old. Now you can receive your distributions, which are 5%, so you're now receiving $10,000 each year. In 10 years, at age 72, you're going to break even. And that's if every goes just right. It took 22 years to get your money back. (Of course, there's inflation risk, but I'm trying to keep it simple)

As you can see, I'm not a huge fan. If and when interest rates go up, maybe the caps will improve, but for now, the only people I can see purchasing these products are going to be very conservative and risk adverse.

In the next post, I'll go over how some of these products are sold and why agents love to sell them.

In the meantime, stay healthy and feel free to let us know if you have questions.


Chris Castanes is the president of Surf Financial Brokers, as well as a professional speaker helping sales people be more productive and efficient.