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Variable Annuities

Are annuities a good investment? (Part 2) #Annuities #FixedAnnuity #VariableAnnuity

Most annuities allow you elect an option in which your beneficiaries are guaranteed to get back some minimum amount when you die. However, with this option, companies charge higher mortality expenses and your monthly payouts are considerably lower. The Economics PhD wouldn’t recommend this option because doing so misses the whole point of annuitizing. Of course, those elections are the main selling point for many annuity salespeople whose sales went through the roof because of the declining stock market and somewhat misleading sales practices.

When the stock market started declining in 2000, sales of variable annuities took off. With a variable annuity, you are not guaranteed a fixed monthly income like a fixed annuity, but you get to invest part of the money in the policy in mutual funds, so there is the hope of getting better returns than you would with a fixed annuity. They were sold to consumers, who had just lost their shirts in the stock market, as a way of staying in the stock market without all of the inherent risk.

Annuity sales went through the roof because the people selling them emphasized the option in which your heirs receive a minimum amount back on the policy in the event that the mutual funds declined. So if you bought an annuity for $100,000, and died the next year when the mutual funds inside the annuity brought the value of it down to only $90,000, your beneficiaries would get back either the $100,000 you put into the policy, or maybe something more than that.

Sometimes the policies even go up by a certain percentage every year, so your beneficiaries would be guaranteed to get more than you put into it. When the market is going down every day, it is easy to sell that guarantee to somebody. The sales people sold it as a “win-win” solution. You have the upside potential of the stock market, with a guarantee that your beneficiaries will at least get the money you put into the policy, and maybe even more.

What is that guarantee really worth though? Remember, the insurance company charges you extra for that guarantee. It is not included in the regular expenses of the policy. To get to the true cost of that protection, we need to go over a couple of things.

First, what are the odds of having an annuity for any length of time and having the investments be worth less than what you put in? Well, it is very possible within the first year, or first couple of years, and I guess that rids the buyer of the “get hit by a bus” nightmare scenario we described earlier. However, after 5 or 10 years the odds of a diversified mix of stocks and bonds having a value below where you started are pretty low.

Even if it does happen, how much do you think your account value could have declined by? The price you pay for that guarantee is pretty high. If you were really concerned that your beneficiaries receive some minimum amount when you die, you might buy life insurance instead.

High commissions pose another reason for the commonality of annuity sales. Commissions of 4-8% are common and commissions of 10-12% are not unheard of. People usually invest fairly large amounts when they buy annuities. Investments ranging from $50,000 to $500,000 are very common. So annuities are big-ticket items that pay big-time commissions. Someone who sells you a $500,000 annuity and pockets an 8% commission makes $40,000. You read that right, $40,000.

That is a powerful incentive for an agent or broker to sell you an annuity. Mix that with the fact that most of the people who sell them probably don’t really understand the guarantees that they are selling to the public, and it makes for a whole lot of annuities sold.

Michael Garry Yardley Wealth Management

Author Michael Garry Yardley Wealth Management

Michael Garry is a CERTIFIED FINANCIAL PLANNER™ practitioner and a NAPFA-registered Financial Advisor. He is a member of the National Association of Personal Financial Advisors (NAPFA) and the Financial Planning Association (FPA).

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