Investing with common sense: Questions and answers about annuities

Last week’s column generated some great questions about annuities. I’ll try to answer some of the most common here.*

Why don’t you like annuities?

I don’t like annuities. They have their place in the right situation. I don’t like it when annuity sellers sell them inappropriately.

Simply put, what is an annuity?

These are life insurance products that, in addition to generally providing a death benefit, generally also include living benefits. These may include capital protection, monthly income, minimum growth rates, long term care riders or others.

When might an annuity be inappropriate?

Many have higher fees and commissions than other investment options which will impact the rate of return, often significantly. Many also have high early redemption charges. Inappropriate use would be when a buyer has unrealistic expectations of the products’ potential performance or results.

Why do many annuities have early redemption charges?

The insurer incurs costs of marketing and issuing an annuity which it recovers over time with margins and/or fees for the owner. If you cash it early, the insurer must recover these costs.

Give an example of when you might recommend an annuity?

I will give two. An individual asked me how he could leave money to a wayward child. They feared that the child would waste the money if they received it in a lump sum. I offered a few options and the one they chose was an annuity that paid a lifetime monthly payment to the child. I explained that I expected the returns to be significantly lower than what they might earn in other investments, but that because the payout was guaranteed for life, it might be better than leaving the child wasting money. As a side benefit, the child would have a lifetime monthly reminder of his parents’ love for him. A – Many years ago, during a period of high interest rates, we found fixed rate annuities that were paying returns of around 8% guaranteed for 10 years. It made sense for some of our customers to be able to lock this down.

My agent told me that a Fixed Indexed Annuity is invested in a risk-free stock market index. What does it mean?

You can’t actually buy a stock index. These often complicated products use various methods to “tie” potential gains to a market index. The key is to realize that they have limits on how much of a win they can capture. Understanding these limitations and having realistic expectations of potential growth can help you determine if these often long-term products are suitable.

Rents are inherently neither good nor bad. They have their place and their time like most financial products. My personal feeling is that they are sold much more often than they should be. The key is to work with a trustee who puts clients’ interests above their own in helping them decide if these products are right for them.

Full disclosure: I do not personally own any annuities, but I have listed some in my trust to allow for managed distributions to my heirs.

Note – FINRA/SIPC, a Registered Investment Adviser – * Annuities are complex products and should only be used on proper advice and after careful consideration of benefits and costs. The answers here are very generalized and simplified for educational purposes only.

Dan Wyson, CFP® is the author of “The Gold Egg” and “21 Financial Myths” and owner of Wyson Financial/Wealth Management 375 E. Riverside Dr. St. George, UT 84790 — 435-986-9525 — Securities and Advisory services offered by Commonwealth Financial Network, member.

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