The theme this week on the Retirement Quick Tips Podcast is: Investments I Hate. 

Today, I’m talking about annuities. Of all the investments I’m talking about this week, I actually hate annuities the least, but they’re so oversold by advisors and insurance salespeople, and so many of you listening no doubt own an annuity, so I think it’s worth discussing why I hate annuities. 

An annuity is an insurance contract with the intention of paying out some type of income stream in the future. There are many different types of annuities, but at their core, most have some type of future guaranteed income stream associated with them.

The most common types of annuities I see are variable annuities, so I’m going to use variable annuities as today’s example of why I hate annuities. Variable annuities are usually invested in with a lump sum - usually a rollover from a 401k. 

Then the funds in the annuity are invested in a diversified portfolio, and several years later, once you’re retired, you can draw income from the portfolio. 

Annuity illustrations used by salespeople are usually pretty rosy, highlighting the high income stream that you’ll be guaranteed for the rest of your life. That’s because annuities are often sold with these extra bells and whistles, known as riders, which provide some type of guaranteed income stream.

The problem with annuities is that they are usually terrible investments. The fees are quite high - usually around 3% annually, which really eat into the principal value of the annuity. So if you decide later on that you want to cash in your annuity and invest in something else, you’re likely to be pretty disappointed with your overall returns.

Part of the reason for those high fees is that the salesperson selling the annuity receives a fat commission when you buy the annuity. Usually around 4-6%. So if you have a $500,000 rollover, the person selling you that annuity is looking at a commission somewhere in the range of $25,000. I don’t sell annuities with commissions, and it would take me about 5-6 years to earn the fees that the annuity salesperson would earn with selling one contract. So if the incentive structure for selling annuities gives you pause, you have good intuition. 

Most annuities are too complex for the average investor to properly evaluate, and like many of my other hated investments, there isn’t a lot of standardization, so it’s hard to do a proper comparison between different types of annuities. 

An annuity does make sense for a very conservative investor who wants to create a pension-like income stream for themselves. An annuity can accomplish that, and like many pensions, the income stream loses it’s luster over time as inflation eats away at the buying power of your guaranteed income stream. 

Another thing I don’t like about annuities is that they’re hard to get out of until you own them for about 7 years. Most variable annuities have a 7-year surrender charge so if you sell within that time, there’s a penalty you’ll have to pay. That’s a long time to be stuck in an investment, and most of the time, I’m just waiting it out with my clients who were sold a craptastic annuity, so we can move on to something better once the 7-years has come and gone. 

That’s it for today. Thanks for listening! My name is Ashley Micciche and this is the Retirement Quick Tips podcast. 

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Tags: retirement, investing, money, finance, financial planning, retirement planning, saving money, personal finance