Here are some insights for existing annuity contract owners and for anyone considering the purchase of a new contract...
If you own an annuity, here are some important things to do now...
Review your contract to understand the benefits and expenses associated with the plan.
Review the insurance company's rating to make sure it is still solid. (AM Best)
Review the tax status of the contract. Depending on your situation, it may make sense to begin
distributions. You might be able to take periodic payments from the account or annuitize the
contract and receive fixed payments for a fixed period of time or life.
Things to know before you buy an annuity:
Specifically, we need to discuss the 2 basic types of contracts and why they are both potentially problematic.
Fixed annuities issued today offer VERY low rates of return. In order to sell the annuity, the
company might offer a "teaser rate" that is only good for 1 year. After the honeymoon, the
rate usually drops below that available on CDs! This sounds like a good deal, doesn't it!
And you are locked into a surrender period that means you can't change your mind and bail
out without a huge penalty.
The other problem with fixed annuities is that your money is NOT insured. Insurance companies do run into financial trouble on occasion and guess who gets stuck holding the bag when one fails?
Variable annuities issued today can get very complicated, often sold with a "have your cake and eat it too" sales pitch. Get stock market like returns with a guarantee that you will at least get
your money back in case of another financial collapse. The problem with these contracts is that
they are very complicated and involve VERY HIGH FEES and a long surrender period. And all the
fancy guarantees become dubious if the company is placed under severe financial stress (2008).
Another major issue with annuities is what I call "the time bomb effect". When used for non-qualified money (Not IRA), the account value is often left to accumulate for the beneficiary. The problem with this strategy is that the beneficiary gets hit with heavy taxes in many cases when the contract is cashed out. There are more efficient ways to take income (for example, dividends which are taxed at a low rate) and accumulate capital (for example, stepped up basis on stocks) for the next generation.
Review the "Choosing a Financial Advisor" page and "Fee Comparison" page on my website and arm
yourself with solid information before buying a new annuity. Also review the Minnesota Attorney General's warning on annuities.
When used intelligently, fixed (NOT index) annuities may make sense. Fixed annuities with shorter surrender time frames and issued by highly rated insurers, can look and feel a lot like CD's. While these are uninsured, risk is very low compared with many other types of options out there.
Todd's Tax Service LLC
Todd's Tax Service LLC