Annuities Have Their Place, But Avoid the “Steak Dinner” Routine

Have you ever been invited to attend a “free” steak dinner, courtesy of a financial advisor or two?  Periodically, it crops up at The Villages, and if you don’t come across one here, you almost certainly will at some point if you’re one of tens of thousands of so-called “snowbirds” in The Villages who spend at least half of the year living someplace north of Florida.

Should you be invited to one of these dinners, be wary.

These advisors are pitching an annuity, typically one or two, and it’s not in your interest to take this seriously.  It’s not that annuities overall represent a problem.  Many annuities make sense, especially for retirees without a traditional pension and who are somewhat worried about outliving their savings. In addition, plenty of older people think twice about investing everything in traditional stocks and bonds, which tend to go down as well as up.

Before contemplating a purchase however, some learning and analysis is crucial. It’s important to pick one or two annuities that best fit the bill for you in a vast annuity market encircled by numerous insurance companies.

At a steak dinner sales pitch, as often as not you will be persuaded to buy one of many popular fixed indexed annuities (FIAs). These enable you to get a piece of the action in the stock market in a good year and guarantee that you will not take a loss in a bad year. FIAs are good annuities, but some are more attractive than others, which means one specific FIA is definitely not optimal for everybody. Moreover, FIAs in general aren’t necessarily right for many retirees, especially if they care about potentially strong returns.  

Also bear in mind that the insurance broker or brokers pitching an annuity or annuities at a steak dinner are likely to focus on the types of annuities that offer the highest commissions for them — not necessarily the annuities that may be best for prospective buyers in the room.  In addition, the presentation will likely have a limited timeframe, making it extremely difficult to thoroughly discuss the nuances of multiple types of annuities.

When considering buying an annuity, prospective buyers should not go to a steak dinner but instead look for a firm that prioritizes transparency, offers a wide range of reputable annuities from various insurance companies, and has a reputable record of good customer service and financial stability.  They also should provide unbiased advice tailored to a prospective buyer’s financial situation and investment mindset. And, too, it would be a plus if a prospective annuity buyer could shop at a financial firm with at least one or two certified financial planners, who have a fiduciary responsibility to put the financial welfare of a prospective client first.

In my case, I have purchased several annuities, as well as so-called alternative investments – investments outside of the traditional categories of stocks, bonds and annuities. I have been an investor in stocks and bonds for decades and still am, but decided to spread my wings roughly a decade ago because I have long been bothered by bear markets, perhaps more than average. I thought it best to be as diversified as possible in my retirement years, thereby enhancing the odds of not coming up short.

Investments of virtually any sort are, in part, a matter of personal psyche.  Subsequently, it’s common knowledge that annuities aren’t for everyone. Just as stocks, bonds and alternative investments have their downsides, as well as upsides, so is the case with annuities. One overrated downside, however, is the commissions that annuity purveyors pocket, commonly in the 3% to 7% range. While high, insurance companies pay this to successful brokers. Annuity buyers themselves don’t pay the commission.

But there is a catch, and this is that annuities come with stiff surrender penalties, typically 5% to 12% annually for years, decreasing over time.  Many annuities allow annuity contract owners to withdraw up to 10% a year without penalty, but, of course, there are times when annuity owners have to pull out more, and sometimes everything.  Prospective annuity buyers have to take this into account before actually buying the annuity.

In addition, annuities don’t face taxation until money is withdrawn from the investment. But once this occurs, annuity payments are taxed as regular income. By comparison, stocks, for example, are taxed at the lower capital gains rate after one year.  Younger annuity owners also must take into account that any money withdrawn from an annuity generates a 10% penalty if the owner is less than 59 1/2 years old.

Not surprisingly, these details bring out the critics. One is overwhelmingly traditional stock and bond investor Fisher Investments, a huge, Texas-based independent money management firm. Could Fisher be right in downplaying annuities?  It’s highly unlikely. Annuities have been selling at all-time records for three consecutive years. Small wonder, given that many annuities guarantee lifetime income, a feature you won’t find elsewhere. Moreover, the federal government has long allowed Americans to invest in annuities in IRAs. And, more recently, some 401(k) plans now offer annuities as an optional investment option, strongly suggesting that the federal government and sizeable companies fundamentally endorse annuities.

Even many financially comfortable retirees periodically worry about having enough money to live out their retirement in relative comfort.  In particular, it can be very jarring for someone to see their investment portfolio drop sharply relatively soon after they cash their last paycheck. It happened in 2008 and can happen again.  Moreover, losses early in retirement are especially challenging because they can dig a hole that is tough to get out of later.  Lifetime guarantees don’t exist in traditional financial markets. But they do in many annuities.

This also a good time to buy select annuities because interest rates, while down some from their peaks in 2023 and 2024, are still otherwise the highest they have been since the early 2000s.  The higher the rates, the better the deals offered by insurance companies.  Accordingly, if near-retirees and retirees haven’t done so already, now is a better-than-average time to take a good look at annuities at a reputable financial firm.

Because they are somewhat illiquid, annuities are a secondary, not a primary investment. Nonetheless, they’re an important offering for the retirement set.