The world of finance is full of perceptions and misperceptions about annuities. As an overview, annuities are a broad category of financial instruments that is a good tool in certain situations. However, by lumping all annuities into one category, it is unlikely you will identify the specific annuity that is best suited for your particular situation. So, let’s put those negative notions about annuities ON HOLD, and dig a little deeper. This month, we’ll engage in an impartial look at annuities offered by a Certified Financial Planner™ Practitioner with more than 30 years of experience in the financial services profession who offers both annuities and their competing financial products.
Let’s take a look at common perceptions about annuities and explore whether they are based on truth or a myth.
PERCEPTION #1: ANNUITIES PROVIDE LOW GROWTH
When we use relative terms, we have to be careful we make appropriate comparisons. “Low” growth is a relative term. “Low” growth compared to what? Let’s start by identifying the objective of the annuity. Some annuities are intended to provide lifetime income or a death benefit or be targeted to help with long-term care costs. For these annuities, growth is not a relevant measure because they are not intended to be used as an investment. When growth is the intended objective for an annuity, the interest fixed annuities earn should be compared to other safe alternatives, like CDs, annuities actually provide excellent growth. It is true their expected return is not as high as stock which are relatively risky investments and therefore not an appropriate point of comparison.
PERCEPTION #2: ANNUITIES HAVE HIGH FEES
Conversely, the vast majority of fixed annuities offered in the market do not have any fees. This is true of fixed rate annuities and most index annuities with growth tied to the stock market. Some carriers offer consumers the option to earn a higher interest rate by selecting an interest allocation that does have a fee. By and large the only fees charged by fixed annuities are for optional riders including income and death benefit features, which consumers will pay for when they are specifically looking for annuities with those benefits. Variable annuities, (a different class of annuity products) do have relatively high fees including administrative fees, mortality and expense charges and investment fees. None of these fees are charged by the base product offering of virtually all fixed annuities.
PERCEPTION #3: ANNUITY OWNERS PAY BROKERS HIGH COMMISSIONS
It is true that brokers receive commission to sell annuities, but the commissions are paid by the annuity companies as their cost of doing business. The annualized commissions brokers earn over the surrender charge period of an annuity are typically less than the annual commissions securities-licensed brokers would earn selling mutual funds over the deferred back-end load period, or corresponding front load commission. Also, fee-based portfolio advisors have a much higher compensation opportunity to earn their fees (often at a higher annual percentage than annuity commissions) for the entire length of their relationship with clients. Ironically, securities-licensed brokers and fee-based portfolio advisors who offer financial products that complete with fixed annuities are avid proponents of the perception that annuities pay high commissions.
PERCEPTION #4: ANNUITIES ARE NOT SAFE
To the contrary, fixed annuities are low risk investments due to their relative safety. While the value of stock and bond investments in investors’ variable annuity accounts have investment risk, the value of fixed annuities is ensured by the annuity company as part of their general obligation. To protect their policyholders, annuity companies are required to have reserves that exceed their financial obligation for the annuities they issue. The underlying investments held by the annuity company, the financial security of the annuity company and tight government regulations and oversight are the reasons fixed annuities are low-risk.
PERCEPTION #5: ANNUITIES ARE NOT LIQUID
It is undoubtedly true that annuities have limited liquidity (owners can typically withdraw up to 10% of their account value per year, after the first anniversary), but there is much more to consider. The three most important characteristics of a financial instrument include safety, performance (growth or income) and liquidity. There is no vehicle that provides all three liberally. To secure the combination of safety and performance that annuities offer, they need to be less liquid. Increasing liquidity by using other vehicles would require taking on investment risk or reducing anticipated returns. With proper planning, a consumers’ liquidity needs should be met across their entire portfolio of assets—not by each individual holding.
Keep an eye out for our AUGUST Blog, continuing this topic with “Annuities: Separating Truth from Myths, Part 2”
