Annuities: What to Consider
January 12, 2023Historically, annuities have been a controversial topic and often subject to criticism among financial advisors. And, to some extent, there is good reason for this. Annuities have been synonymous with aggressive sales tactics and high fees. But is there ever a case for purchasing an annuity? And what are the options if you already own one?
What is an annuity?
In simple terms, an annuity is a contract between an individual and an insurance company.
One type of annuity is called an Income Annuity. With an Income Annuity, an individual makes a lump-sum payment to the insurance company and in return, the insurer agrees to make periodic payments that continue for a lifetime – no matter how long (or short) that lifetime may be.
Another type of annuity, called a Deferred Annuity, is more “investment like.” Unlike the Income Annuity, a Deferred Annuity account increases (or decreases) depending on if the annuity is fixed or variable.
Why do Deferred Annuities get a bad rap?
Deferred Annuities receive the most scrutiny for several reasons; most notably due to fees, aggressive sales tactics, and other complexities.
The fees associated with deferred annuities include mortality and expense charges, high surrender charges, administrative fees, and underlying fund expenses. In addition, there are often high commissions paid to the person selling the annuity (who may or may not have financial planning experience.) The marketing can be persuasive, offering protection and security, playing on fears especially during turbulent market times.
Deferred Annuities can often be complex, making it difficult to understand the terms or how the annuity’s underlying account value increases or decreases. Deferred Annuity owners often learn that they did not receive the benefits they were seeking or that they did not fully use the features they paid for.
Deferred Annuities also offer riders or “add ons” (think dealer options offered with a new car purchase). These features enhance the product either during life or at death, but come with an additional cost. When it comes to utilizing these features, the nuances around how it all works can be very confusing.
Is there ever a case for a new annuity?
When a client seeks protection against longevity risk (the risk of outliving their resources) and wants pension-like income without market risk, we may evaluate an Income Annuity option in their financial plan. Knowing that there are many factors to consider, we can discuss the pros and cons and help weigh all options. As fiduciaries, we put our clients’ interests first. We are not compensated for recommending annuities or any other products. Because of this, we can provide unbiased advice.
What are the options if you have a Deferred Annuity?
If you already own a Deferred Annuity, Modera can help you evaluate your options. We first want to understand the purpose of the Deferred Annuity – why was it bought and do those reasons still exist? That will help us determine if there is a better solution.
We then review the annuity to understand the features and how it works. Some things we consider:
- When was it purchased?
- Is it held in an IRA?
- Are there living or death benefits?
- What are the fees?
- Is the annuity subject to a surrender penalty?
- Are there tax consequences if the contract is surrendered?
Once we have those answers, we can evaluate options. One option may be to surrender (i.e., cash out) the annuity. This may increase income taxes and lead to other unintended consequences. Another alternative is to exchange the annuity for a new annuity without tax consequences. Modera can help identify options for low-cost, no-frills annuities.
It also may be possible to take smaller, partial withdrawals that increase taxes on a more controlled basis. Even if the annuity is still under a surrender period, there is typically a penalty-free withdrawal available (usually 10%). And if the contract has little or no gain, the tax consequences of cashing out may be negligible.
And a final option is to keep the annuity as it is. After fully examining the annuity, it may be best to keep it and come up with a plan to maximize its benefits. This may mean coming up with a plan to “turn on” income by utilizing the riders. We can help by incorporating it into the financial plan.
Annuities can be complicated. At Modera we provide unbiased advice to help individuals understand and make informed decisions on their annuities as part of their financial plan.
Modera Wealth Management, LLC (“Modera”) is an SEC registered investment adviser. SEC registration does not imply any level of skill or training. Modera may only transact business in those states in which it is notice filed or qualifies for an exemption or exclusion from notice filing requirements. For information pertaining to Modera’s registration status, its fees and services please contact Modera or refer to the Investment Adviser Public Disclosure Web site (www.adviserinfo.sec.gov) for a copy of our Disclosure Brochure which appears as Part 2A of Form ADV. Please read the Disclosure Brochure carefully before you invest or send money.
This article is limited to the dissemination of general information about Modera’s investment advisory and financial planning services that is not suitable for everyone. Nothing herein should be interpreted or construed as investment advice nor as legal, tax or accounting advice nor as personalized financial planning, tax planning or wealth management advice. For legal, tax and accounting-related matters, we recommend you seek the advice of a qualified attorney or accountant. This article is not a substitute for personalized investment or financial planning from Modera. There is no guarantee that the views and opinions expressed herein will come to pass, and the information herein should not be considered a solicitation to engage in a particular investment or financial planning strategy. The statements and opinions expressed in this article are subject to change without notice based on changes in the law and other conditions.
Investing in the markets involves gains and losses and may not be suitable for all investors. Information herein is subject to change without notice and should not be considered a solicitation to buy or sell any security or to engage in a particular investment or financial planning strategy. Individual client asset allocations and investment strategies differ based on varying degrees of diversification and other factors. Diversification does not guarantee a profit or guarantee against a loss.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.