Lighthouse Financial

Read this article before you sign a Variable Annuity contract!

Annuities tend to become a popular choice during volatile and uncertain market conditions, but are they right for you?

Annuities are touted as investment vehicles designed to help a client create periodic income for his/her lifetime.  These contracts are similar to company pensions, meaning you are guaranteed a specific amount of revenue for life, but lose flexibility and control of the overall asset.  While an annuity may be a tempting solution to generate “safe” returns, before signing on the dotted line, there are a few things you need to know.

Annuities Meet A Few Goals

1. Guaranteed Income

2. Protection from a Down Markets

3. May Offer a Death Benefit

Annuities were created for clients who need guaranteed income during retirement and NEVER intend to surrender the policy. Instead, the client plans to annuitize the assets, once the surrender fees have been eliminated (usually 5, 7, or 10 years) and plans to begin receiving periodic payments in the future. Variable Annuities also fill a need for clients who are incredibly fearful of investing in the stock market. These fears may be driven by the concern that the markets will be in decline or experiencing a recessionary period when the assets are most needed.  Clients select annuity contracts over investments to protect assets from recessions, market corrections, or bear market conditions. Lastly, annuities offer the opportunity for clients to leave a legacy to their loved ones by purchasing a death benefit rider. The cost can be high for the added benefit, but for some clients, it’s the only way to meet their estate planning goals. 

The Downside of Annuities

1. An annuity may not provide the guarantee and protection you expect

2. Fees may eat away your return potential

3.  Annuities are sold as a commission-based product

Let's look at an example: 

This example shows the growth of the guaranteed 4% growth bucket compared to their cash value bucket that is 100% dependent on investment performance (S&P 500).  If this client decided to withdraw their funds in 2009, they would have received $69,244.13.  On the flipside, if the client chose to annuitize the contract, they would have received annual payments based on $136,856.91.  Think of a variable annuity as an insurance contract with a cash value.  You invest a lot in premiums and the company grants you the ability to have a cash value, but that cash value will never be the same as your guaranteed bucket.  The idea is that you can invest in the market and benefit from appreciation, but with fees hovering around 3.5 – 4% your performance returns have to soar to beat your guarantees. While a client can hope for massive returns, in reality, most annuities don’t provide the ability for double-digit returns. 

Here is another drawback, most annuities, but not all, allow you to invest in market funds, and to get a diversified mix you have to select more than one fund.  The sales agent may not disclose that each fund selected may have additional, internal fees which are paid annually.  The combined impact of disclosed and non-disclosed fees can be upwards of 4% annually for annuities.  If you currently hold annuity contracts, it is recommended that you have a deeper discussion with your agent to determine the true fee structure and net performance that your annuity is providing. If the total cost of your annuity is more than 1.5% annually, you may be better off working with a FEE-ONLY wealth management team. FEE-ONLY firms have non-commissioned fee structures and hold a fiduciary responsibility to put your needs first, always.

In the example above, the client paid the annuity company $32,000 in fees for the protection of his initial premium.  Are the benefits of the annuity worth the price?  

Bottom Line

Do not invest in an annuity unless you want guaranteed insured annuity payments at a future point in your life.  Do not put all of your investment assets into an annuity if you want liquidity.  Distributing more than 10% a year during the surrender period can result in steep penalties of 7% or higher depending on the year you draw down the assets.

Annuities are very complex in nature, and they are often sold to clients that don't completely understand how they work.  Annuities are also a commission-able product; providing advisers up to 7% commission.  Always be informed when you’re thinking about investing in an annuity. Do your own due diligence and give us a call at 714-572-8900 to learn more before you sign on the dotted line. 





3. Kriesel, W. T. (September, 2015). The Pluses and Minuses of Variable Annuities: Choosing the Right Options for the Planning Situation. The CPA Journal, 26-31.


*The foregoing content reflects the author's personal opinions which may not coincide with the opinions of the firm, and are subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. All investing involves risk. Asset allocation and diversification does not ensure a profit or protect against a loss. Finally, please understand that–as with other social media–if you leave a comment, it will be made public.