Why annuities are a bad idea for almost 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 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.
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.