This might sound familiar: someone comes to you and tells you about all the dangers to your lifestyle in retirement. In fact, they claim, the only way to protect your quality of life is through guaranteed income.
That word, “guaranteed,” makes you feel secure. You want a guarantee.
And then you buy an annuity.
And you will never know exactly how much money you will lose in your lifetime.
Photo by Carla Anne on Unsplash
What are annuities?
For those who have not yet encountered them, an annuity is a contract you can make with a company. Usually, in exchange for a sum of money now, they’ll give you a steady income over a period of time later.
Annuities are often sold to people about to retire, who are worried about their income when they will no longer be able to work.
In fact, these are so popular that studies show that over a third of American households (38%) have annuities.
So what’s so bad about them?
The general concept of annuities isn’t bad. However, there are several reasons why annuities are not the magic cure-all that has been touted by the industry. The top three issues from our point of view are:
1 – How they’re sold
2 – How expensive they are
3 – Annuities do a poor job of protecting against inflation and other surprises
Let’s go into these issues one by one.
How they’re sold
When you purchase an annuity, you’re buying it from a salesperson. This might seem obvious, but it’s important to remember that salespeople are not fiduciaries, and therefore don’t necessarily have your best interest in mind.
Agents will have a disclosure in their brochure stating that when selling certain products, they do not have that fiduciary responsibility. That’s a huge thing to give up, and it comes at a cost to you.
Annuities are some of the most profitable tools that companies can sell. Because of this, those companies are willing to pay an arm and a leg in commission to agents when one of these annuities is sold.
If you have a friend who’s been trying to sell you an annuity, we’re not saying that they’re a bad person. However, they’re in a position where they have a definite conflict of interest. They might believe that an annuity is the best choice for you. But behavioral science has shown us that positive reinforcement, such as high commissions, will create a bias in our minds.
Because of this, annuities have been sold as a solution for everything. Worried about retirement income? Try an annuity!
Not worried about a steady paycheck, but want to invest your money? Try a variable annuity!
Don’t have much money, but worried about income later? Try a deferred annuity!
As people started to catch on to the bad deal annuities provide, companies responded by adding complexity and riders, still claiming that annuities can solve all of your money woes.
The truth is, annuities try to do a lot, and aren’t great at any of them. And you’re definitely not getting what you paid for.
Annuities are expensive
How much are annuities worth to companies? In 2020, even with a pandemic, annuity sales reached $219.1 billion. As we said a moment ago, companies make so much money off of these annuities that they strongly incentivize their agents to sell them.
That commission, and the profit beyond that, comes from you. That is money you pay that you do not get to benefit from in the future.
“But wait,” you might say, “Where is their profit? Where is that commission?”
Especially with variable annuities in which you can track stock performance, these expenses can be difficult to spot.
Looking under the hood of annuities, you’d be surprised at how high their fees run. Remember, a good financial advisor will cost you about 1% total. Meanwhile, average fees on a variable annuity start at 2.3% before adding any additional riders.
For context, if you have a variable annuity, and the stock market goes up 8%, you will only see a 5.7% return. If you bought a $100,000 annuity, that means that yearly you’re paying $2,300. Over 30 years, however, through fees, and their foregone earnings, it will have cost you $505,597.99!
Annuities do a poor job of protecting from inflation and other surprises
Traditional annuities only pay out a flat amount. Well, over time, inflation will go up, but the annuity payment won’t.
This means that traditional annuities lose purchasing power over time.
Of course, it’s possible to purchase an extra rider to adjust for inflation, but those are usually incredibly expensive.
Beyond that, however, annuities do a poor job of planning for ordinary life surprises. Life has a way of surprising us with expenses, and not all of them bad! Suppose you are blessed with grandkids, and you want to help them pay for college. By sinking most of your money in an annuity, you’ll leave yourself with very few options.
The bottom line
You could probably tell that we’re not big fans of annuities. There are other ways to save and prepare for retirement that are cheaper and much more effective.
Of course, there are also a limited few situations where an annuity is the correct choice for a person.
If you would like to learn about some alternatives to a costly annuity, or what you can do if you’ve already purchased one, click here to sign up for a free Bronze account. One of our licensed advisors will reach out to set up a 60-minute consultation to help you explore your options.