These popular retirement income products may promise more than they deliver, and often with hefty fees.
Both financial regulators and planners are warning customers more and more to consider whether an annuity is right for them. While gaining in popularity, annuities are retirement income products that tend to offer better-than-average returns but at a high cost to the consumer.
Sales of annuities have increased over the years as insurance brokers and agents try and convince older Americans that this product is a smart way to boost retirement income. However, what these agents omit is that indexed annuities can be extremely complicated, often fall short of their promised returns, and carry very high surrender charges and fees.
Certified New York City financial planner Tony Isola says that these types of annuities resemble investment timeshares in that they’re challenging to get out of, the brokers are often misleading, and the costs are high. Isola recalls helping clients in their 70s who purchased annuities and then had to wait for another decade to get out of them to avoid paying high surrender fees. Isola says they didn’t understand what they were getting into or what they owned.
If you ask anyone in the insurance industry, they will tell you that indexed annuities offer investors the chance to avoid the returns of alternative fixed-income sources and regular annuities. Vice president of Nationwide Financial, a provider of insurance and annuities, Michael Morrone says that the stock market has been strong in recent years and individuals nearing retirement wouldn’t want to miss out on the principal they’ve gained. Morrone further states that indexed annuities are ideal for retirees who don’t want the volatility of the market but want more upside than fixed investments provide.
According to an industry research group, LIMRA Secure Retirement Institute indexed annuity sales reached a record of $20 billion in the second quarter, which is an increase of nearly 20% since last year. The agency predicts that by the end of 2019, indexed annuity sales will surpass $70 billion.
This uptake in sales is what caused the Securities and Exchange Commission to release an investor bulletin to explain the potential risks associated with indexed annuities. Director of the SEC’s Office of Investor Education and Advocacy Lori Schock said that because of the growth in the number of sales of indexed annuities the agency felt it had a responsibility to release accurate and unbiased information to potential investors.
Locally, several state securities commissioners have seen an increase in the number of insurance agents who are not properly licensed to make recommendations on 401(k) plans. More so in Vermont, but other states have experienced this problem as well, says Michael Pieciak, North American Securities Administrators Association president and Vermont Department of Financial Regulation commissioner.
Costs and Complication
Regular annuities offer a fixed payout which differs from indexed annuities that experience the ups and downs of the stock market. CEO and President of Des Moines-based life insurance and annuity research firm Sheryl Moore further explains the process. She states that indexed annuities don’t invest in stocks. Instead, the money is invested in stock options and bonds, and the returns are dependent on a formula linked to an index.
Furthermore, indexed annuities typically put a cap on the payout, sometimes at 6-8%, which doesn’t include dividends. So your return may be lower, even if the stock market experienced strong gains.
Glenn Daily, a New York City-based fee-only insurance analyst, said that the problem with indexed annuities is that it’s very difficult to understand what you are getting for your money. Investors can get some peace of mind in the form of a minimum guaranteed rate of return, typically 0-3%, to protect them even if the market fails.
Most indexed annuities carry surrender charges, up to 10% of the overall value, and other fees that consist of 2-3% of the annual return. Certified financial planner based in Murrieta, California, Scott Dauenhauer says that what it comes down to is that you may be getting a net return that resembles a CD or a bond than in the stock market.
Conflicts of Interest
Many of the costs associated with indexed annuities can only be found in the fine print of the contract.
Micah Hauptman, Consumer Federation of America financial services counsel, says that individuals typically aren’t aware of these conditions because the annuity salesperson isn’t transparent during the free lunches and dinners they offer retirees to get them to sign up.
Often an independent agent that works for various carriers, annuity salespeople typically receive a 5-8% commission for signing retirees up. Furthermore, according to a 2017 report by Elizabeth Warren, agents may also receive free vacations, cash awards upon reaching sales targets, and other bonuses.
A rule put in place by the Labor Department during Obama’s time in office would have put a stop to some of these incentives by requiring the disclosure of conflicts of interest. It also would have enforced that advisers take on the role of a fiduciary to put a customer’s best interest before their own. However, the rule was put on hold in 2018, and indexed annuity sales have continued to rise in the meantime.
Income Alternatives
If you need to create sustainable retirement income, here are three possible alternatives to annuities:
1. Take advantage of your Social Security. The most reliable annuity you can use is from Social Security. Steve Vernon, consulting research scholar at Stanford Center and author of Retirement Game-Changers says that from Social Security you have access to a guaranteed, inflation-adjusted income over your lifetime. Determine the impact of filing at various ages because for each year that you wait to file, your payment increases until you max out at age 70. Vernon says that purchasing an annuity doesn’t make financial sense for those who want to claim early. What he recommends is that you save the money you would have spent on an annuity to cover your living expenses for another year before withdrawing from your Social Security.
2. Focus on low-cost annuities. While you may need additional guaranteed income from your annuity to cover expenses, Isola recommends that you limit your investments to 20-25% of your portfolio. For more retirees, it’s smarter to stick to a low-cost option, like a single premium immediate annuity, which offers investors a regular monthly check after investing a lump sum.
3. Have a withdrawal strategy. Lastly, your portfolio can be designed to include a withdrawal rate that will protect you from running out of money for 30 years. This includes building a diverse portfolio of bonds, stocks, and other fixed-income assets such as index funds. Typically, it’s best to initially withdraw 4% and then adjust that for inflation for the coming years. Michael Kitces, Pinnacle Advisory Group director and certified financial planner, says that this strategy has historically performed well even in bad markets.
