The Pros and Cons of Annuities

(previous) PAGE 9 of 9

1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - FAQ - Top Annuity Lies

Index Annuities - Immediate Annuities

Life Insurance


What you can do if you own an annuity now....

1) SWITCH TO VANGUARD IN A TAX FREE 1035 EXCHANGE - If the "surrender period" of your current annuity has expired then speak to your accountant about possibly switching to one of Vanguard's extremely low cost annuities through what's known in tax code as a tax-free "1035 exchange". Vanguard is VASTLY cheaper than the "retail annuity" that you were sold by your commission hungry "adviser". Vanguard's annuities have no insurance company "surrender periods", meaning if you want to get out at any time they impose no fees. Vanguard deals directly with the public and so this eliminates the "contingent deferred sales charge" that would otherwise be used to make sure you stay the course while paying high fees year after year to make up for your adviser's lavish commission. CLICK HERE to use Vanguard's cost calculator to see how much you will save in the first year by switching to Vanguard. It is critical that you speak to a tax adviser before proceeding.


If you are currently on a systemic withdrawal (SEPP) program, be absolutely certain to speak to a tax accountant to be sure that you follow the rules of a 1035 exchange. For example the money should be sent directly to the new insurance company, by direct deposit if possible. Be sure to restart (continue) the SEPP program in the same dollar amount and on the same day. Don't worry if either insurance company incorrectly declares that your SEPP program has been broken. They will likely code the prior year's withdrawal and / or future withdrawals as a "1" (early distribution). This error is actually "normal" because for liability reasons they don't want to underwrite it. Your accountant will likely tell you to simply change the coding to a "2" (early distribution with exception) on your tax return. I am told that filing a form 5329 is optional but recommended.


In deciding whether to do a 1035 exchange, whatever you do don't ask the non-fiduciary who sold you your current annuity (or the guy who is currently listed as your agent on your quarterly statements) because he will try to talk you out of switching in order to retain the 1/4% trailer fee that he earns year after year. Vanguard does not pay any commissions. Don't speak to yet another non-fiduciary "adviser" either as they will simply try to sell you yet another expensive commission based product. In order words don't make the same mistake twice!


2) CONSIDER STARTING A SYSTEMIC WITHDRAWAL PROGRAM - If you're under the age of 59 1/2, the insurance company surrender period has expired, and you're already invested in the lowest cost annuity that you want to stay in until age 59 1/2, then one thing that you can consider is taking advantage of is a systemic withdrawal program that allows you to begin taking money out of the annuity without incurring the 10% Federal tax penalty (or your state tax penalty). Then invest that withdrawn money in a normal portfolio of ETF's (like you should have done in the first place). Understand that since annuities are taxed at such a high rate ("ordinary income" rate) that at the time of distribution you will have to keep those distributions to a minimum in order to keep your taxes from getting out of control. This higher "ordinary income" tax rate one of the unavoidable and nasty downsides of annuities. However, at least a systemic withdrawal program offers a nice opportunity to minimize your ordinary income tax rate, especially if you are not generating a lot of income now. From my individual experience, under a systemic withdrawal program I was allowed to begin taking out approximately 5% per year. Your heirs will greatly appreciate it as well, since money from those gains will finally become stepped up. It is critical that you speak to your tax accountant.


3) CONSIDER GETTING PARTIALLY OR COMPLETELY OUT - Speak to a tax adviser who understands annuities and taxes. Be sure to make it clear that you have absolutely no interest in having them ever manage your money otherwise you might get biased advice. You want just a one time fiduciary consultation. If you are perhaps about age 40 or younger and think that either you might need some or all of your money before you turn age 59 1/2 and / or you just want to earn higher returns (after paying the pre-59 1/2 Federal and State surrender penalties) then surrendering some of all of your annuity now may or may not be a good move. If your annuity is no longer subject to the insurance company surrender penalties then you might want to consider admitting that you made a mistake and surrendering your original principal. You will still have to pay the mandatory 10% Federal tax penalty and State tax penalty (before age 59 1/2), and ordinary income taxes on any gains. The move might become a net gain after perhaps 20 years by instead being invested in low cost index ETF's.


Crunch the numbers using tax preparation software then get together with an accountant for their opinion. Be sure to compare hypothetical annual savings with the lowest cost annuity out there (that generally means Vanguard). Don't compare fees with your current annuity because a 1035 exchange is the other option that you will likely want to choose (if you don't get out completely). When comparing a portfolio of ETF's with a Vanguard annuity you will likely save about 0.7% per year because you would eliminate their 0.3% "mortality and expense" charge and the roughly 0.4% sub-fund management fee markup. Think of that 0.7% as pure savings that would be recouped each year. You should be able to make up for the state and federal tax penalties within 20 years. If you have gains, then yes they will also be taxed, but you will eventually have to pay those taxes anyway. Remember one of the purposes of getting out is to eliminate even more ordinary income taxes on future gains within the annuity. Again it is critical that you speak to a financial planner / tax accountant before you make this very bold move. Don't rely on this website for any kind personalized advice.


If the market ever takes a major hit like it did in 2008 then this might be a golden opportunity to consider pulling all or a lot of your money from your annuity at a "tax fire sale". At a market bottom like that of 2008, this would be the equivalent of getting out by paying 50% less in tax penalties compared to had you gotten out at the market peak of 2007.


If you are planning to withdraw a lot of annuity gains (not principal investment) then your taxes should be lower if you split up those withdrawals up into more than one tax year. Programs like TurboTax are very useful for creating hypothetical tax situations. For example withdrawing 25,000 in annuity gains might cost you 10% plus 14.5% in ordinary income taxes, whereas withdrawing $50,000 might cost you 10% plus 22.3% in ordinary income taxes. If the ordinary income taxes scare you then consider that you will eventually be paying ordinary income taxes on gains anyway.


Another tax consequence to consider is that once you turn age 59 1/2, are you going to want to start quickly liquidating your annuity in short order? If you liquidate large amounts quickly, your ordinary income tax rate could be very high, in which case it might make more sense to take smaller amounts out before your turn age 59 1/2. These are all complex questions that you must ask a tax adviser about.


4) CONSIDER TAKING THE MOST RISK OUTSIDE OF YOUR VARIABLE ANNUITY - If you have investments outside of a variable annuity then hopefully you view the big picture of both accounts to represent your entire portfolio. But do you diversify within the variable annuity and diversify within your separate account? Mindful of the fact that your annuity will be taxed to death at the ordinary income rate, a better approach might be to use the variable annuity for your conservative investments (such as bonds) and your separate account for aggressive investments (stocks) as much as possible. Over time your separate account should perform better than the annuity. This will save you in taxes and this will allow you to eventually withdraw money from your annuity faster since the annuity will have appreciated in value less. Remember annuity withdrawals must be tightly controlled (due to the higher annuity tax rate).


5) Eliminate any unnecessary "Cadillac Policy" extras that your broker may have added on such as unnecessary "death benefits" and riders. These add-ons boost your broker's commissions.


Beware of any adviser who suggests that you switch to yet another expensive "retail" annuity product

Brokers, insurance agents and other advisers earn huge commissions not just when they sell you an annuity, but when they get you to switch from one annuity to the next. They make lots of money off of transactions! Don't be surprised if at some point you get a phone call from Mr. Broker urging you to switch 100% of your annuity to what he says is a "better" annuity. If he is urging you to take an early withdrawal penalty (contingent deferred sales charge), then report him to the Securities and Exchange Commission (SEC). Even if you were talked into switching annuities at a penalty you should have up to 10 years to report that broker to the SEC.


In California, after years and years of fraud and abuse, it was finally written into law that the insurance company is now held accountable for making sure that an annuity sale or exchange is suitable to the investor. By law one thing that now signals a red flag is when an agent wants to process an annuity exchange or replacement within less than 5 years. But in other states that don't require the insurance company to scrutinize annuity transactions you may not be protected from a broker who wants to churn your account. Even in California the law doesn't go far enough. The "suitability standard" only protects you from blatantly unsuitable advice. There is no substitute for fiduciary advice. As previously stated, fiduciary advisers will virtually never sell annuities because they are inferior investments in so many ways.

Whenever you are asked by any adviser to exchange one annuity for another, always ask for a comparison of the old and new product, as well as a breakdown of the costs and benefits. Absolutely be sure that it is all presented to you in writing, as this will protect you legally. Then compare this so-called "new" and "better" annuity product to Vanguard. Also do a little research on your own to determine when this "new" and "better" annuity product first became available. If it was already available when your broker sold you the first annuity then this is proof positive that your are being fleeced. Contact the SEC to see if your broker may have violated securities law.


SIDE NOTE: It's very rare that a "fee-only" fiduciary adviser would ever recommend that a client invest in an annuity. If his name is listed on your quarterly statements it may be that he is "double dipping" by illegally earning compensation from the insurance company. Report him to the SEC to be sure that he is not double dipping.


The one case that makes good sense is the recommendation to switch to one of Vanguard's annuities. However don't expect Mr. Broker / Adviser / Insurance Salesman to tell you about Vanguard because he won't make any money out of the transaction. Vanguard does not pay sales commissions so only fiduciary advisers will make this recommendation. Because Vanguard does not pay commissions, their annuities (such as their variable annuity) have extremely low fees. Vanguard sells their annuities directly to the public. CLICK HERE to see how much you will save versus your current annuity.


Beware of anyone who tries to get you to switch your money out of a retirement account (such as a 401k) into an annuity

For starters nobody should even begin to consider an annuity unless and until they have maxed out their 401K. There is no advantage to switching your money from a retirement account (such as a 401 K) into an annuity. Money in retirement accounts like 401K's are already tax deferred. Switching to an annuity is only going to erode your savings through the higher hidden fees that annuities have (and are described on this site). Just for fun, put them on the spot and ask them why they aren't recommending a Vanguard annuity.


Also nobody should put more than 50% of their savings in illiquid financial products. Chances are that if your 401K is maxed out, you have much more than 50% of your money locked in prison for many years.


Just how much commission money did your broker earn for duping you into investing in that annuity?

Whatever the insurance company percentage penalty is for withdrawing money within the first year is probably very close to the percentage of your investment that he earned. So if you invested $100,000 and there's a 7% penalty for withdrawing money in the first year, followed by 6% in the second year, 5% in the third year, and so forth, then he probably earned about $6,000 or $7,000 from the insurance company. Sometimes insurance companies allow brokers to structure their payment so that they earn less up front but more in annual "trailer fees" for each subsequent year that you continue to hold the annuity. That trailer fee might be 1/4 percent of the investment (or $250 per year based on a $100,000 investment). Now you know why they push annuities so hard! All of this money comes indirectly out of your annuity investment through high fees!


When confronted, broker / agents often try to make their high commissions seem par-for-the-course by comparing it with the high fees that you would otherwise pay if you were working with an asset manager. But this is a flawed comparison because you don't want to pay someone to constantly manage your money either! A fiduciary "asset manager" is better but certainly not as good a choice as simply hiring a fiduciary for a one-time consultation (if you can't do it yourself).


Only about 1% of annuities are purchased directly from insurance companies by investors. About 99% of annuities are sold by commission hungry brokers, insurance agents and bank salesmen. This explains the paradoxical "popularity" of annuities.


A dirty little secret: If your broker's name is listed on your quarterly statements, then simply having his name removed should cut him off from any future "trailer fee" commission payments!

After reading this page you are likely very angry at your broker for selling you an annuity. If so, there's something you can usually do to get back at him where it hurts -- his wallet! All you have to do is call up the insurance company (that issued your annuity contract) and tell them that he is no longer your broker and to simply remove his name from your statements. As far as I know you don't need to replace his name with any other broker's name. Having NO broker listed will suffice just fine. Also if you choose to have a new (trusted) investment professional listed, this should not cost or save you anything either. The "new" broker will instead earn the trailer fee. As a result, if your old broker is earning yearly "trailer fees" from the insurance company as most do, then those annual "trailer fee" payments to him will end. If you're angry because your broker never discussed with you all of the negative things about annuities described on this page, then I say don't let your broker get rewarded each and every year for shamelessly leading you astray.


youtubeBeware of other websites and You Tube videos that appear to present unbiased annuity "pros and cons"

If you search the Internet for "annuity pros and cons" there are lots of websites that appear in the results. Ditto for You Tube. Unfortunately many of the top search results are sites that are hosted by none other than the very brokers and insurance agents who sell these investment products! So what you really get is mostly lies, exaggerations and LOTS of omissions. Often you can pick out these web sites out just by looking at the domain names. They might have the word "insurance", "retirement", "senior" or "annuity" in their domain name. They are likely to use scare tactic statements like "Will you outlive your money?" Don't be confused by these biased web sites. I have created a list of trusted articles (below) about annuities that are NOT hosted by biased insurance agents, brokers, and other commission hungry salesmen.


For once get an unbiased second opinion!

If you somehow manage to ignore everything on this site, and still wish to invest in an annuity, please be sure to get not just a second opinion but a good second opinion from a fee-only fiduciary investment adviser -- Not from a non-fiduciary free "adviser", broker, insurance agent or bank employee who legally does not work for you. These non-fiduciaries cannot be trusted to give any type of personalized financial advice. CAUTION: Brokers may legally call themselves "financial planner", "investment adviser" or just about any title they choose. The key is that you want to hire a "fiduciary" adviser who charges you a fee for their services and signs a fiduciary contractual agreement and provides you with a Form ADV which discloses how they are compensated! This way, at least legally, they must work for you and your best interests!


Beware of anyone who suggests that you invest a large percentage of your savings in annuities or any other illiquid investments

Never lock a large percentage of your liquid assets away in any illiquid investments for many years. There is absolutely no way to predict whether you may need that money. A fiduciary adviser knows this, while commission based "advisers" ignore this. Even if you are somehow convinced by a sales person that you need to lock your money away in an annuity, you probably wouldn't want to lock up more than 5% of your savings in an annuity -- that's savings -- NOT total net worth, including your home equity. You broker may have violated securities law if he recommended that you invest 50% or more of your total liquid assets in illiquid financial products like annuities.


Insurance agents and reps don't fully understand annuities

You will have to hire your own accountant or lawyer to oversee / resolve important decisions / issues

You would think that with all of their training, annuity sales agents and insurance company customer service reps would know the in's and out's of annuities. But annuities are so convoluted and complex that it's common knowledge amongst CPA's and insurance industry people that very few do! There are endless horror stories to be told about investors losing lots money due to being given erroneous information. This is why it's critical that you hire a CPA (for perhaps $275 per hour!) to advise you on such things as deciding whether to start a systemic withdrawal program, whether to proceed with a 1035 exchange, or any other important decision. And hopefully they will give you the correct information! Annuities and the way that they are taxes is complex and convoluted for everyone, and that's just one more reason to avoid annuities altogether! Remember that normal, liquid investments like ETF's do not involve entering into binding contracts, signing wordy paperwork, or hiring CPA's to mull over fine print. Investing in ETF's is as simple as placing a buy or sell order through your deep discount brokerage with a few mouse clicks.


Remember an annuity is a complex contract, and with it come complex legal and tax issues. In some situations you may have to hire a lawyer or CPA to resolve disputes with the insurance company or IRS, which could be very expensive. For example it is common that after a 1035 exchange that the surrendering insurance company will report a preexisting SEPP program as being broken. If you don't address it on your own, your prior SEPP payments are then subject to a 10% IRS (plus state) penalty even though they may not be. Step one is to hire an accountant to attempt to resolve the issue. In a worst case scenario you would have to fight the IRS in court. A 1035 exchange may also increase your likelihood of being audited by the IRS, which will cost you money.


floridaIs there any reason that might justify investing in an annuity?

Speak to an attorney. Likely the only situation that might justify locking your money up in an annuity would be if 1) you have high income, 2) you feel you are at risk of being sued (and losing), 3) you won't consider a trust, and 4) you live in a state like Florida that legally protects retirement accounts from judgments. Remember that OJ Simpson moved from California to Florida specifically to protect his existing annuity from an impending civil wrongful death lawsuit before he was sued. Even in some scenarios, a simple insurance policy might shield you from certain types of lawsuits and would be a much better choice. For fear of everyday lawsuits, simply increasing your homeowner's and car insurance is often sufficient, making no need for locking your money up in any annuity. In situations like this, more than ever it is critical that you never rely on a broker or insurance agent for personalized advice on whether to buy or not buy an annuity as a shield against law suits. In fact it is against the law for a broker / insurance agent to give legal advice and to sell you an annuity based on that unauthorized practice of law. Only an attorney can advise you on whether it makes sense to put your money in an annuity in order to protect your money from creditors. If any adviser has sold you an annuity based on "legal advice" that he gave you then they have likely broken the law and you may have a case against him to not only get your money out of the annuity prison without penalty, but to get additional compensation. If and when an attorney does advise you to buy an annuity, only then hire a fiduciary registered investment adviser to help you select an annuity -- not an insurance agent or non-fiduciary.


If you do decide to invest in an annuity be sure to only invest in annuities that are backed by insurance companies with the HIGHEST safety rating. Moody's, Fitch, Weiss, S&P and A.M. Best provide such ratings. Also, with risk avoidance in mind, never invest more than perhaps 25% of your state's guarantee amount with any one insurance company if that annuity may happen to be backed by a state fund. And compare management fees, mortality and expense fees and other annuity fees with other annuities.


CONCLUSION: Annuities are just not worth it when you consider the sky high management fees and the lethal surrender costs. And investing in an annuity is like putting your money behind bars until you turn 59 1/2 or even longer. Don't put your money in prison! Stop being played by your self-serving broker/adviser who does not represent you and your best interests! Avoid anyone who tries to convince you to invest in an annuity, or for that matter any investment that has a "surrender fee", "early withdrawal penalty", etc. If your broker didn't tell you the annuity cons described on this page then give them a tongue lashing and leave for good. If they are also charging you an annual fee, only to recommend long-term investments like annuities then I'd investigate if they may have broken fiduciary laws. If you are only in your 20's or 30's and they are pitching annuities then slam the door after you leave! And finally run for the hills from anyone who suggests that you invest a huge chuck of your nest eggs in an annuity! If you need stability and/or steady income then take a look at a mix of CD's, bonds, bond ETF's, high dividend paying stocks, low volatility index fund ETF's, etc. Take a hard look at how easily the 85 / 15 portfolio (described above) has beaten index annuities over the years. Seek out a fee-only fiduciary financial adviser if you need help. Studies have shown that over time, "passively managed" index funds (ETF's) have outperformed professionally managed funds like annuities and "actively managed" mutual funds. And you can sell that ETF any time you want for only about ten bucks a trade, with no early withdrawal penalties or "surrender fees", and you pay only the sensible "capital gains" tax rate.


Also be sure to warn friends and family about annuities! As always, consult with an unbiased, fee-only financial planner before making financial decisions. People who push annuities should never never ever be trusted as "financial advice givers". Instead consult with a fiduciary.


Still not convinced? There's plenty more to read about annuities and the "advisers" who shamelessly push them....


As reported in BusinessWeek: According to the NASD, investors who bought into annuities made at least 7,000 complaints about variable annuities in 2003.

Forbes Article - The Truth about Equity Indexed Annuities.

Forbes Article - The false promises of annuities and annuity calculators.

YouTube Video - Exposes the false promised returns from annuities that have income guarantees.

Don't let this annuity horror story happen to you - True story about a woman who was sold a variable annuity.

Article about annuity fraud - Be sure to read the section entitled "What is the Problem with Variable Annuities?"

Great article explains how if you invested $5,000 a year in a mutual fund versus the typical annuity that has 1% more per year in fees. After 30 years you would have missed out on nearly $70,000 in gains -- and that's before taxes! After taxes the annuity is taxed up to 20% more! Invest in ETF's and that $70,000 gap is almost certainly going to be wider. Just avoid annuities!

The odds of a tax-sheltered account beating an index fund are quite poor

Great article about index annuities

Don't be Suckered into a Variable Annuity

What to do if you own an annuity

Article about annuities

Short talk about why brokers push annuities over mutual funds

Dirty Little Secret: Broker Commissions and Investment Fees

Have you been the victim of securities fraud? This law firm will go after your broker!

Santa Clara University Study reveals that in 3 case studies annuities have NO tax advantage

Understanding "ordinary income" taxation VS "capital gains" taxation

Study - William Reichenstein's 85 / 15 portfolio easily beats an index annuity.

Annuities slammed for failing consumers in England

Variable Annuity Scam - 3/13/2014 - Charges filed against brokers, an adviser, an investment advisory firm, and several others.


(previous) PAGE 9 of 9

1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - FAQ - Top Annuity Lies



OR MOVE ON TO THE NEXT ARTICLE: Avoid oddball investments


Disclaimer and Waiver - Nothing on this consumer advocate website is intended as investment, tax, accounting or legal advice, as an offer or solicitation of an offer to buy, hold or sell, or as an endorsement, of any company, security, fund, product or other offering. This website, its owners, affiliates, agents and / or contributors are not financial or investment advisors or broker / dealers and assume no liability whatsoever by your reliance on the information contained herein. The information should not be relied upon for purposes of transacting securities, assets, financial products or other investments. Your use of the information contained herein is at your own risk. The content is provided 'as is' and without warranties, either expressed or implied. This site does not promise or guarantee any income or particular result from your use of the information contained herein. It is your responsibility to evaluate any information, opinion, advice or other content contained. Always hire and consult with a professional regarding the evaluation of any specific information, opinion, or other content.