The Pros and Cons of Annuities

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Index Annuities - Immediate Annuities

Life Insurance


Conflict of interest: You will never get the truth from anyone who is involved with this transaction!

Later when you find out the truth about annuities and get angry, life insurance companies will tell you "it's not our responsibility to warn you of this" and "it's your responsibility to discuss this with your accountant" and they'll tell you that this information is already disclosed (or rather buried) in the prospectus fine print, which of course nobody reads or understands, and your broker never discusses it with you or only tells you what you want to hear (the happy talk). Remember that anyone who pushed an annuity on you is nothing more than a salesman. They do not provide personalized investment advice in your best interests.


There's misinformation and half truths everywhere

Beware of supposed "annuity pro and con" websites that have words like "annuity", "retirement", or "senior" in their domain name. You have to ask yourself why would anyone go to the effort and expense of creating these sites? For charity? No. They are trying to sell annuities with the usual happy talk, half truths, commissions, etc. These websites don't even begin to scratch the surface about the cons.


For example, easily more than half of the web sites I found about annuities shamelessly have either NO mention of the fact that money distributed prior to age 59 1/2 is also added to your adjusted gross income (and taxed again and taxed mightily as "ordinary income") or it's presented vaguely or sort of buried in the small print.


At right: In a You Tube video by Allianz Insurance they mention the state 10% penalty. No mention of the state penalty and no mention of the higher ordinary income tax rate!


Here's an investment advisory company that only mentions the 10% IRS withholding penalty, completely omitting any mention of the additional state and federal "ordinary income" taxes that you pay.


Here's an annuity salesman who only mentions the 10% IRS penalty (at 1:52).


I received an advertisement in the mail from a California broker whose web site says that "Distributions of earnings are taxed as ordinary income and may be subject to an additional 10% federal income tax penalty if taken prior to reaching age 59½.." No mention of any California withholding tax penalty!


On one insurance company's website it says "Withdrawals are subject to ordinary income tax, and if taken prior to age 59½, an additional 10% federal tax may apply." No mention of any state withholding tax!


There's also quite a few videos on You Tube that are presented as what would appear to be unbiased "educational videos" when in fact they are actually annuity promotions in disguise. These videos usually omit most if not all of the talking points found in this article.


Another common trick is to advertise index annuities as paying a high rate of return. In reality they are only quoting a "teaser rate" that only applies to the first year. Thereafter your rate of return typically goes down to perhaps about 1%. Or they may advertise what sounds like 7% annual returns to some investors, when in reality the annuity pays a paltry 7% total return.


Bail to get out of prison early is really... really costly!

And with variable annuities you must also pay perhaps a 7% surrender penalty if for any reason you need cash out in the first year. Each subsequent year (for 7 more years) the life insurance company penalty drops by 1%. On average index annuities begin with 12.5% early withdrawal penalties. Fixed annuities usually begin with 7.5% early withdrawal penalties, and decline gradually for up to a whopping 16 years.


So by investing in an annuity you are taking a huge risk that you might need this money. According to one source, 25% of annuity holders do withdraw money early.


92% of American Equity Investment Life's business is in index annuities. In 2009 they collected $63 million just in surrender penalties! That's about 63% of its operating income! That tells you that a lot of people seriously regretted investing in index annuities!


A culture of deception: Hidden fees that they never tell you about

Annuities have annual administrative costs, subaccount management costs, and other fees that typically total (on average) 8 tenths of one percent more than those expensive "actively managed" mutual funds as well as annual "mortality and expense" charges. Remember that actively managed mutual funds are also expensive and should be avoided! "Turnover rate" will typically cost your account about 1% per year. The grand total in annuity fees might be somewhere between 3% and as much as 8 1/2%. This is how they recoup that hefty 5 - 14% commission that they paid out to the sales rep who duped you into investing in the annuity in the first place! Remember that YOU indirectly pay for that hefty sales commission that your broker earned when he duped you into buying the annuity! The insurance company recoups this broker fee and trailer fee by charging you annual management fees that are about .8% more than mutual funds. And you thought that you were getting a bargain when there was no "front end load" fee to pay (as is common with certain mutual funds that brokers sell). Adding insult to injury, annuity companies are not even required to disclose what their fees are in the statements that they send you! Look on your annuity quarterly statements and amazingly you will find no mention of these other annual fees. Usually they only mention the small (approx $30) account maintenance fee.


BELOW: An actual annuity statement that deceptively shows only a minuscule $30.00 annual administration fee. In reality an additional 3.118% in fees are subtracted annually! Unless you took the time to dig through and decode a complex legal book called a "prospectus" you would never know.



Unless you dig into and comprehend that annual multi-page book they send you called the "prospectus" you wouldn't begin to understand the sky high fees. Even after reading the prospectus, unless you had intricate knowledge about what exactly "turnover rate" means and how it works, you would never know that this shaves a substantial amount of money off your investment every year too.


Remember that annuities are issued by insurance companies, which are publicly traded companies. They are in the business of making money and employing workers, which is costly. They make money off of you! They are not managing your money for charity! Ask for a book called a prospectus and buried deep inside, if you can decipher all of the legal talk, you will find what they are really charging you. You will be shocked to find out that it's much more than they are divulging in your quarterly statements. Your broker almost certainly never told you about the devil in these details or he glossed over it like it was nothing!



THE UGLY: Here's a typical example of a real variable annuity product fees:


Amazingly the only fee you will ever see on your statements (which are sent quarterly) is a $30 annual "administration fee". Completely deceptive! The real fees associated with this particular variable annuity are hidden inside a complex 39 page book called a "prospectus" that reads like law text, and which of course few investors understand unless he happens to be a lawyer.


1.4% of total account value - Annual "mortality & expense fee"

1.56% of sub-account Growth & Income "management fee" (comparable to S&P 500 index) - Turnover rate = 67%

0.78% of sub-account: Growth "management fee". Turnover rate = 82%

1.34% of sub-account: Multi Asset "management fee" (comparable to Russell 2000 index). Turnover rate = 53%

0.59 of sub account: Government & Quality Bonds "management fee". Turnover rate = 66%

0.82% of sub account: Natural Resources "management fee". Turnover rate = 82%


If your money was evenly allocated among the above funds, when averaged out, the grand total annual percentage in fees that you would pay is over 2.418% of the total value of your account. Not $30.00 dollars! These fees do not include "turnover rate" costs which averaged 70%. Assuming that a turnover rate of 100% equals about 1% in costs then the grand total in fees and expenses for this typical annuity is about 3.118% per year. And that's considered "low cost"!


THE GOOD: Here's a comparable portfolio of ETF's and their expense ratios (fees):


0.19% - FCD - Seeks investment results that correspond, before fees and expenses, generally to the price and yield performance of the Morningstar Consumer Defensive Index. Turnover rate = 4%

0.3% - FEU - Seeks to replicate as closely as possible, before expenses, the price and yield performance of the STOXX® Europe 50 Index. Turnover rate = 7%

0.15% - IWB - Correspond generally to the price and yield performance of the Russell 1000 Index. Turnover rate = 6%

0.1% - BND - Vanguard Total Bond Market ETF seeks to track the performance of a broad, market-weighted bond index. Turnover rate = 73%

0.4% - GNR - The investment seeks to replicate, net of expenses, the S&P Global Natural Resources Index. Turnover rate = 32%


If your money was evenly allocated among the above funds, when averaged out, the total annual percentage in fees that you would pay is over 0.228% of the total value of your account. These fees do not include "Turnover rate" costs which averaged 24.4%. Assuming that a turnover rate of 100% equals about 1% in costs then the grand total in fees and expenses for this typical portfolio of ETF's is only about 0.472% per year.


CONCLUSION: With this typical "low cost" variable annuity you are paying about 2.65% more per year in fees and costs than had you invested in a simple portfolio of comparable ETF's. This is something no broker or insurance salesman will ever tell you! William Reichenstein has said flat out that "the typical annuity with expense ratios approaching 2% or higher is not in the best interests of investors". Also think about this: A broker typically earns about a 5 to 7% commission right off the top plus a 1/4% "trailer fee" commission every year for as long as you stay invested in the annuity. This is his compensation from the insurance company for duping you into investing in the annuity. Insurance companies are also publicly traded companies that are in business to earn profits of their own. They make money too! Where do you think all of that money comes from? It comes from you!



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