Is an annuity appropriate for me?
With a $2.5 million portfolio in mostly fixed income, is it necessary to have $200,000 in a variable annuity? The fees are very high, and the sales pitch rationale is that I have no pension otherwise. Is this true?
Hi, you are right to be suspect. The fact is if less than 10% of your assets would be in equities, this is totally unnecessary. I would advise to look at USMV, the Ishares Low Volatility index. Even with a 40% drop in the value of your equity investments that would only represent an overall drop in your portfolio of 3.2%. So the question is simple, can you deal with a 3.2% drop in your portfolio? Good luck, and always trust your instincts! Also, make sure to check out your high yield bond exposure, this can act like equities in a downtown.
What is your risk tolerance, time horizon, and income need (now and in the future)? Do you anticipate any large expenses such as paying for a child/granchild college, a second home, etc.? Are you protected for unexpected events such as a long-term care need? These are just a few of the items that need to be determined before even thinking about making a recommendation.
While one might be able to make a case for it, most likely a variable annuity is not the best solution for you. It probably makes sense to diversify by adding in some other asset classes such as equities even if you are a conservative investor as studies have shown that an all fixed income portfolio has been considered to have a lower risk/reward profile than that of one that has some equity exposure. Since you are questioning whether or not this recommendation by the Financial Advisor is appropropriate or not, I would meet with a Certififed Financial Planner acting in a fiduciary capacity which you can find one near you by visiting http://www.letsmakeaplan.org/.
I just love this kind of question. Let me begin with the fact that I'm a fee-only financial advisor and have no products to sell whatsoever. Annuities in and of themselves are simply another form of investment although in most cases, extremely expensive, easy to get into and difficult to get out of. Unless you have a specific need to guarantee a specific dollar amount of monthly income for yourself or for you and your bride, I would avoid annuities like the plague. They do provide tax-sheltered growth but with the portfolio you have in the amount of $2.5 million, I'm sure your getting decent advice from other people. If you get tempted to purchase an annuity for any reason, look for what is called a low load annuity product which can be found that tends to strip out most of the commissions that would otherwise be due to a product sales person. This does not make a product sales person a bad person. It does however provide the "potential": for conflict of interest that needs to be addressed. One of the great questions to ask any salesperson is what they will earn in the year of the sale and each year thereafter. Most are extremely reluctant to even discuss this issue much less tell you the truth but it's something you should see to understand the cost of the product. I hope this helps a little and good luck
I am definitely not a fan of annuities - especially in your case. There are much better tax - savvy ways to save. For more info, please read my info below.
First, an annuity is an insurance contract – the purchaser gives the insurance company money and the company promises to pay a stream of payments starting now (an immediate annuity) or in the future (a deferred annuity). With most immediate annuities, the monthly payment will be paid for the rest of the client’s life (or a fixed period of years). With most deferred annuities, the ultimate payout depends on how the annuity’s investments have performed.
If you are able to ask questions before signing the dotted line, you can counter the salesman’s various pitches as follows:
“Your investment is insured against loss.” The annuity has built-in insurance that will pay your heirs what you originally put into the contract if you die before taking out your money. Truth is, this insurance is practically worthless (because over time your investments should certainly be worth at least what you put in!) and it’s expensive.
“Your money will be there when you need it.” Ask the salesman about surrender charges. The annuity that he’s selling will penalize you for pulling your own money out early. The penalties can be as much as seven to ten percent and “early” can mean anything less than seven to ten years!
“You don’t pay me any commission.” Sure you do – indirectly! The insurance company will pay your salesman three to eight percent of what you invest. Of course, the insurance company has to be paid back somehow; they get repaid through surrender charges and high fees.
“Your money is safe.” Your money is only as safe as the insurance company issuing the annuity and the annuity’s underlying investments.
“You’ll get big tax savings.” It’s true that you don’t pay tax on income earned inside the annuity. However, as soon as you start taking money out, you’ll pay taxes – at the highest rates. The income portion of each payment you receive will be taxed as ordinary income. Outside of an annuity, you could get capital gains rates. Unfortunately, in an annuity, all of your gains come out as ordinary income. Also, investments held outside an annuity pass to your heirs income tax-free (stepped-up to fair market value). With an annuity, your heirs pay tax at ordinary income rates on the entire gain.
“The annuity offers superior investment options.” With most annuities, your investment options are extremely limited. You’ll be stuck with choosing from a few “captive” high-cost mutual funds.
In addition to dispelling the usual arguments, be sure to be aware of a few other points.
- Just because someone manning a desk in a bank’s office recommends an annuity does not mean the bank is recommending an annuity. That person is earning a commission and the principal is not FDIC insured.
- An annuity should not be purchased within a tax-deferred account, such as an IRA. There is no benefit to paying the extra costs and fees of a tax-deferred annuity when the IRA is already tax-deferred!
- You should beware of an insurance person’s recommendation to roll an old annuity into a new one. You might incur a surrender charge and can start the clock ticking on a new surrender charge.
Technically the statement that you have no pension is true, but it is also misleading. Your portfolio of fixed income acts like a pension and provides you income to live even if it does not guarantee you income should you spend the entire nest egg. Assuming that you have done proper planning and are comfortable with the 2.5 million providing enough income for you, then there is no need for an annuity. The only time an annuity would make sense is if you spent your portfolio and then lived off the income from the annuity. Even in that case, the annuity income on $200,000 will be much lower than what you are currently receiving from your portfolio. The times an annuity would make sense would be if there is a good chance you outlive your money and even then you are wagering against numerous actuaries that make a living off making these calculations.
Best of luck as it appears you already have the right frame of mind.