Annuities Are a Bad Idea for Almost Everyone
By MARC LICHTENFELD | March 6, 2018 10:48 a.m. ET
Betting the insurance company that you’re going to live longer than they think you will.
“Don’t lose money in the Wall Street casino!” the radio announcer blared.
“It could take a lifetime to make up your losses in the stock market.”
Unless your lifetime is five years — that’s how long it took the market to make a full recovery after the Great Recession — he’s dead wrong.
He was using this fear tactic to sell annuities. And getting suckered into buying an annuity with him — or any broker — could be the biggest mistake you ever make.
You see, annuities aren’t wrong for everyone… Just most everyone.
If you’re unfamiliar with annuities — you give an insurance company your money and in return they pay you an income stream, usually for the rest of your life. In some annuities, if you die before you’ve received all of your money back, too bad for you. The insurance company keeps the money.
Seriously, that’s how it works.
Now, there are plenty of annuities where that’s not the case. Family members can receive cash back or even continued monthly income after your death — but you pay extra for that.
Essentially, you’re betting the insurance company that you’re going to live longer than they think you will. They take your money, invest it and give it back to you in dribs and drabs (with steep penalties if you want to withdraw more than the contract states).
Annuities are such terrible investments that the minute the government passed a law specifying that financial professionals had to act in their clients best interest, annuity sales fell off a cliff.
In 2016, new rules were passed by the Department of Labor that stated that brokers have to act as fiduciaries. That means they had to put their clients’ best interest ahead of their own.
Believe it or not, prior to the rule being passed, stock and insurance brokers could sell you anything they wanted — whether it was right for your or not. So typically, they sold whatever paid the highest commissions.
Annuities pay extremely high commissions — often 7% or higher of the total amount. So if a client was sold a $200,000 annuity, the salesperson might take home $14,000 up front.
Needless to say, there’s not a lot of incentive for him to put you in a low-cost index fund.
This new law is scheduled to go into effect this year, though that will likely be delayed.
As soon as the fiduciary rule was passed in 2016, sales of annuities fell 8%. They slid an additional 18% in the first quarter of 2017.
Sales of variable annuities, which are the worst of the worst, crashed 22% in 2016.
If these were such wonderful products, as defenders of annuities will maintain, why did so many people stop selling them — even before the law went into effect?
So why do people like them?
Fixed annuities prevent losses. You are typically guaranteed that the value of your principal will not go down regardless of what the stock or bond markets do.
Fixed index annuities allow the investor to take part in some upside, though it is usually very limited — about 4% per year in this low interest rate environment. So the investor is trading upside potential for downside protection.
If the market soars 20%, the investor will only make 4%. But if the market falls 20%, the investor won’t lose any money.
Another way they screw you
Let’s say you take out an annuity and your circumstances change. You need the money urgently. If you’re still within the surrender period, it’s going to cost you. Big.
A typical surrender period is seven years and the surrender charge starts at 7% and falls by 1% per year.
So if after two years, you need your money back, it’s going to cost you $10,000 ($200,000 x 5% = $10,000) to get your own money back.
Instead, take the money and invest it in Perpetual Dividend Raisers — companies that raise their dividend every year.
But I don’t want to risk any money, you say. After all, that’s one of the most attractive features of annuities.
Annuities are typically long-term contracts. People buy them in their 60s, 70s and even 80s, expecting to collect income for years in the future.
Consider that over 10-year periods, the stock market has only been down seven times in the past 80 years. And those seven times all were tied to the Great Depression or Great Recession.
In other words, you had to sell in the depths of historic financial collapses to not make money in the stock market over 10 years.
If you invested in 2000, near the top of the dot-com bubble and sold in 2009, near the bottom of the Great Recession, you were down 9%. Not good, but not horrendous considering you endured two epic stock market meltdowns.
Or consider this scenario… If you have the worst timing of any investor and put your nest egg into the S&P 500 SPX, -0.05% at the absolute top in 2007 — right before the financial collapse — you’d be up 91% (including dividends) 10 years later.
Just stop and think about that the next time market naysayers talk about the “Wall Street casino.”
As an industry saying goes, “Annuities are sold, not bought.”
Don’t be one of the people who gets sold.
This article is condensed from a chapter in ‘You Don’t Have to Drive an Uber in Retirement: How to Maintain Your Lifestyle without Getting a Job or Cutting Corners’.