Annuities: The Good, The Bad and The Ugly

Annuities: The Good, The Bad and The Ugly

By Joe Gaj, CLU, ChFC

April 13, 2016

We constantly get asked about annuities and if they are a good option for retirement planning. Like most financial planning questions, I would answer that question with, `it depends,' specifically on your unique situation and needs.

First, let us define the term annuity, a lump sum of cash invested to produce a stream of income for a fixed period or for life. Secondly, the insurance industry regularly calls their products annuities, even though they may not be producing a stream of income. That is because they are either categorized as immediate (income starting now) or deferred (income starts in the future). To annuitize is when the annuity product starts the income stream.

Unfortunately, there is more to these products that make them frustratingly complex not only for the client, but the salespeople as well. As insurance companies compete in the $230 Billion a year annuity market, they have developed new products with new features and complex contracts. Most brokers have a hard enough time keeping up with the latest products and features, now imagine the millions of policyholders that own these products.

Types of Annuities

Below are a list of the types of annuity products available along with some of the features/riders (be prepared to have your head spin);

Single Premium Immediate Annuity (SPIA): the most basic form of annuity, you give a lump sum to the insurance company, they provide an income stream for specific time period or life, inflation riders are available, liquidity options are limited and surrender charges may apply.

Single Premium Immediate Variable Annuity (SPIVA): same concept as SPIA, except the regular income stream is adjusted based on the performance of your investments vs. the `hurdle rate.' The SPIVA in theory should adjust with inflation due to the investment performance credits, but fees can drag performance and the `hurdle rate' can affect income credits. Liquidity options are limited and surrender charges may apply.

Deferred Income Annuity (DIA): built on a SPIA concept, but your income starts in the future as opposed to immediate, resulting in a larger starting income than SPIA. Inflation riders are available, liquidity options are limited and surrender charges may apply.

Deferred Fixed Annuity (FA): contributions are credited an interest rate annually, interest is compounded and deferred from tax exposure until withdrawn as a lump sum or annuitized. Surrender charges may apply.

Deferred Fixed/Equity Indexed Annuity (FIA/EIA): contributions are subject to increase either by guaranteed minimum interest rate or a credited index rate based on the performance of your indexing method. The most common indexing method is S&P 500 Annual Point to Point which means if the S&P 500 Index has an 8% price increase from your contracts anniversary date to anniversary date, you will receive a credit to your account value based on the contract's crediting formula. The two most common formulas are either a CAP RATE or PARTICIPATION RATE. If the Cap rate is 5%, your account value would be capped at 5% of the 8% index return. If the Participation Rate is 60%, you would be credited 4.8% (60% of 8%).



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Surrender charges often apply, Income Riders and Withdrawal Benefits are available for additional fee and contract bonuses are available.

Deferred Variable Annuity (VA): contributions are invested in separate accounts that are professionally managed. These contracts have mortality and administrative expenses along with the investment expenses. Surrender charges often apply and income, withdrawal and/or principal guarantee riders are available for additional fees. Contract bonuses are available.

Understand these products have both pros and cons and in certain scenarios can add value to your financial plans and objectives. Below is a breakdown of the Good, the Bad and the Ugly.

The Good

Tax Deferred Growth ? If you are a high income earner in a high tax bracket, a low cost variable annuity can make sense if you already maxed out your 401k and IRA deferrals and you expect to be in a lower tax bracket in retirement.

Qualified Longevity Annuity Contract (QLAC) ? allows IRA contract owner to defer income on up to $125,000 or 25% of IRA (whichever is less) to a max Age 85 income start date. This helps defer IRA distributions for those individuals that do not want or need the required minimum distributions (RMDs) at Age 70 ?.

Guaranteed Income For Life - the purest form of `annuity' has value where in exchange of a lumpsum, the insurance company will provide guaranteed income for a specific timeframe, most commonly chosen is lifetime. Most retirees like the idea of social security or a pension which provides fixed income for life, these products recreate that idea.

Deferred Fixed Annuity vs. Certificate of Deposit (CD) ? if you rely on the safety of CDs and often renew when they come due ? a deferred fixed annuity may be able to provide better interest rates. Plus, the interest is deferred from income tax until you make a withdrawal; unlike CDs whose interest is taxed annually.

Charitable Annuities can provide a nice tax-deductible donation to charity while receiving a portion of your donation as a stream of income for life. Think highly appreciated asset that when sold will be subject to capital gains tax, a Charitable Annuity may help you offset the tax exposure with the charitable deduction, and still provide you the income needed to retire.

The Bad

Interest rates are still hovering at all-time lows, which may be unattractive in a few years when rates are higher. So locking in your rates today may have an opportunity cost later.

IRAs are already tax deferred, so using an annuity for tax deferral in an IRA is largely redundant unless you are looking for a specific insurance benefit or to take advantage of the QLAC idea above (see number 2)

Early Withdrawal Penalties ? like an IRA or 401k, the IRS can enforce a penalty on early withdrawals prior to Age 59 ? from a deferred annuity.

Acronym overload, many contracts have terms GMAB, GMIB, GMWB, GLWB, AIR, Cap Rate, Floor, Participation Rate, MYGA, etc., good luck trying to keep them all straight when comparing products.

Guarantees are only as good as the insurance company's promise and ability to pay. Choose highly rated carriers with multiple lines of business and do not rely heavily on one specific product line.



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The Ugly

Variable annuities and rider fees can drag your investment performance down by 3-4% a year. Be prepared to only take advantage of the rider features.

The hypothetical illustrations that show lofty 7-9% level returns and the product performance and riders seem too good to be true. Ask to see illustrations that stress test the product or actual historical returns, where sequence of returns may affect your product performance.

Contingent Deferred Sales Charge or Surrender Fees can penalize you on withdrawing your money for up to 20 years on some products. This sales charge is there to recapture the up-front administrative costs and commissions paid to the brokers.

Brokers are paid commissions on most insurance products they sell, this commission is often upfront or can provide a trail/renewal commission. The very nature of the commission structure makes it attractive to sell products with high up-front commissions that can be as high as 7 - 8% on certain annuity products. Be concerned of the insurance broker that shows you only one option or if the product he/she recommends happens to be a product from the company he/she works for.

Annuities aren't for everyone. We work with clients evaluate old annuities they to see if they still make sense and discuss situations where annuities might be a good fit for a client's current circumstances. We work with all clients to help them understand their options and weigh the pros and cons of various solutions.

If you have old annuities and would like to perform a review or were considering an annuity product, we can help.

Please contact: Joe Gaj, CLU, ChFC, (908) 821-9774 jgaj@.

Important Disclosures: Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by American Economic Planning Group, Inc. ("AEPG") will be profitable. Definitions of any indices listed herein are available upon request. Please remember to contact AEPG if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. This article is not a substitute for personalized advice from AEPG and nothing contained in this presentation is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. Investment decisions should always be made based on the investors specific financial needs, objectives, goals, time horizon, and risk tolerance. Please remember to contact AEPG Wealth Strategies if there are any changes in your personal or financial circumstances or investment objectives as these changes may impact our previous recommendations. This information is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of AEPG. Descriptions of AEPG's process and strategies are based on general practice and we may make exceptions in specific cases. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.



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