Corporate media is largely aligned against annuities. Could this demonization be driven by financial bias? Traditional financial institutions (Wall Street) spend huge amounts of money advertising on corporate media properties.
What really is the truth about annuities? How can one product be so loved and vilified at the same time? It is because annuities are not the same, there are actually 2 different categories of annuities. All they share is the name “annuity.”
Annuities fall into two different and distinct categories.
Annuities issued as securities and sold by brokers are called Variable Annuities.
Annuities issued as insurance products and sold by insurance salespeople are called Fixed Annuities (also Fixed Indexed Annuities).
Fixed annuities have guarantees and no market risk exposure but their returns might not be as high as a variable annuity. Variable annuities are securities with FULL market exposure and contain fees and expenses. The annuitant can lose value with a variable annuity.
Here are common myths perpetuated by the media:
1: Annuities have high fees
The Truth: Annuity buyers pay no fees when purchasing a fixed indexed annuity. Insurance agents who sell annuities don’t earn a commission from the money a person invests.
Instead, insurance companies pay the agent a finder’s fee, a fee for finding the annuity buyer. 100% of the deposit in a new fixed annuity goes to work immediately.
The only fee a fixed indexed annuity holder would pay is if there is a separate charge for a “special” income rider which is used to maximize income options in the future. If the annuity is surrendered prior to the contractual period, a surrender fee can be imposed. Almost all annuities have options in place to remove money when needed, generally 10% of the annuity value annually. Also, if the annuitant decides to convert the annuity to income, there are no fees.
If an annuity holder abides by the term, they will never pay a fee.
Terms and surrender fees vary by insurance companies and the specific annuity products.
One annuity may only have a 3-year term, another a 10-year term. It’s important to know these terms and the surrender fees upfront before purchasing an annuity.
A variable annuity (a security) works differently with potentially three different types of fees.
- Investment management fees
- Insurance company expenses
- Guaranteed income rider fees
Fees on variable annuities added together can be quite high. Potential variable annuity buyers should know and calculate these fees into their decision-making prior to making any decision. It may be, depending on unique financial circumstances, the fees are not worth it.
2: Annuities are confusing
The Truth: While an annuity may be something new to a potential buyer, annuities are very easy to understand.
An annuity requires a sum of money deposited (fixed annuity) or invested (variable annuity). Fixed annuities are market risk free but returns can be lower. Variable annuities are invested in the different investment options and can be exposed to losses and gains.
An annuity owner must commit to a certain amount of time – the term. The annuity a buyer selects should come with terms that fit their unique financial circumstances.
Annuities are THAT simple.
3: Annuities comes with excessive taxes
The Truth: Annuities are tax-deferred. The annuity holder only pays taxes when they access the accumulated funds.
As long as the annuity is intact, earned interest is not taxed. Once funds are accessed, taxes on the gains within the annuity are exposed. The original deposit is never taxed.
Tax-deferrals can be highly beneficial because the annuity holder can manage future tax liability.
While tax deferral is a huge benefit of annuities, two are downsides of annuities and taxation:
Annuities are always taxed as ordinary income rates and never as capital gains.
In the event of the death of an annuitant, annuities do not qualify for “step-up” in basis and will carry tax liability to the beneficiary.
4: Annuities do not deliver on what they promise
The Truth: Fixed annuities offer guaranteed rates of returns, guaranteed income to the annuitant with a myriad of options and a guarantee of the account value being inherited by a named beneficiary without delay or fees.
Since the inception of the first annuity by the Presbyterian Church in 1740, fixed annuities have been the backbone of millions of American workers and their important retirement funds.
It might be time to take a serious look at annuities and your retirement funds.