Annuities may always be popular because of the guaranteed income stream they provide to investors. But there’s a reason annuities have gotten a bad rap in the past. Choose the wrong annuity and, at best, you may be paying too much in fees, or worse, you could lose your entire investment. With that in mind, here’s a look at five mistakes to avoid when purchasing an annuity.
Choosing the Wrong Insurance Provider
The way annuities work is that investors purchase an annuity from an insurance provider and the money is converted into periodic payments that can last for an entire lifetime. Investors can purchase one with a lump sum or with investments over a period of time, and in return, they get a fixed, variable, or indexed rate of return.
But the annuity is only going to be as good as the insurance provider. If the insurer isn’t able to pay out the claims for whatever unforeseeable reason, you won’t receive your payments. That’s why you want to go with an insurer that has a strong financial footing and is rated highly by AM Best, Standard and Poor’s, or Moody’s, three of the companies monitoring the creditworthiness of insurance providers.
It’s important to make sure the annuity provider has an “A” rating from AM Best, an “AA” rating from S&P, or an "Aa" from Moody’s.
Not Paying Attention to Fees
Nothing in life is free. That guaranteed stream of income is going to be costly. How much it costs depends on your level of due diligence. One of the biggest mistakes an annuity shopper can make is to not pay close attention to the fees associated with the annuity. Just like other investment products, annuities come with all sorts of fees, charges, and commissions of which investors need to be mindful.
The most common fees are going to be mortality and expense fees, administrative fees, surrender charges for withdrawals over the agreed-upon limit, investment management fees, and charges for optional riders.
Understanding all the fees each insurance provider is charging will enable you to make an apples-to-apples comparison and avoid annuity products that have hefty fees.
It’s also a good idea to consider the total cost of fees as opposed to just one area. This is because in some cases one cost may be lower, but overall, the fees may be higher.
Getting Lost in Translation
Annuities can be complicated thanks to the different types and all of the industry jargon. There are fixed annuities, variable annuities, index returns, mortality fees, and surrender charges, to name a few.
There are also different ways to get paid out, whether you are collecting for your lifetime or for a predetermined period.
While getting up to speed with the ins and outs of an annuity can be daunting, not doing so can cost you a lot of money. Choose the wrong annuity for your unique situation, and you may not get the proper payout.
Overlooking the Impact of Inflation
With an annuity product, you are paying today for a guaranteed return at a later date, which means there is always going to be inflation risk. But far too often, investors don’t consider inflation when purchasing an income-generating investment product.
If the returns don’t keep up with the pace of inflation, your money will be worth less come payout time. Investors can either take out more of an annuity by calculating how much they need and adjusting for inflation, or they can purchase an annuity with an inflation protection component.
Failing to Shop Around
One of the worst things any annuity buyer can do is fail to shop around before purchasing an annuity. Every insurance provider is going to offer their own annuity products with their own fees, terms, and surrender charges, not to mention that some providers are going to charge a larger commission than others.
There are also differences in annuity types and investments and in the stature of the company. Some insurance companies are going to be more financially sound than others, while others may be more fly-by-night operations. But annuity investors won’t know any of this if they don’t practice comparison shopping.
To make an informed and sound decision, evaluate at least three insurance providers.
The Bottom Line
Annuities are attractive to many retirees because they pay out a steady stream of income during retirement that is supposed to be guaranteed. But not all annuity providers are created equal, which means they are going to offer different products with different charges.
And let’s not forget that not all insurance providers are on the same financial footing, which could put an investor’s money at risk. Investors have to make sure they understand how an annuity works, as well as have a grasp on the different fees, work with a sound insurance provider, and perform the necessary comparison shopping in order to get the right annuity for their unique needs.