Underscore the Importance of Sidestepping Painful and Lasting Annuity Mistakes

OK, you have done some research on annuities, decided to take the plunge and buy one, and are poised to connect with a wealth management firm.  Congratulations is in order. 

After all, many annuities do what no other investment can: Provide guaranteed income for the rest of your life, helping insure you don’t outlive your savings. The wealth management path is usually the best choice given that these firms typically have at least some diversified annuity inventory and almost always in-depth annuity knowledge. The latter is especially important — annuities are highly complex financial instruments with numerous variations and rider and fee structures.

Before you make the move, however, you should find some time to avoid costly mistakes.

You may well have learned some of these potential mistakes already. Yet few people know all of them and even veteran annuity buyers — who usually don’t think about their latest annuity once the latest purchase is made – not infrequently wind up making a serious gaffe or two.

 Here are the omissions:

• Feeling rushed by an agent claiming the product or bonus is on the verge of “going away.”  “There is never any urgency to buy an annuity,” says Stan Haithcock, a highly prominent and veteran annuity agent. “The only urgency is for you to fully understand the contract,” he adds. The point: You have to take your time to make the right annuity purchase.

• Not fully understanding the annuity type.  Buying a fixed, indexed or structured annuity, for instance, without truly grasping how each works, its risks, and potential returns, is shortsighted.  It’s a mistake, for instance, expecting market-like returns from a fixed indexed annuity even though they have caps or participation rates. It won’t happen.  This thinking sometimes occurs because annuities sometimes are simplified or over-hyped in sales pitches. 

• Ignoring or underestimating fees and charges. Don’t overlook embedded commissions, mortality and expense fees, administrative fees and especially rider fees for guaranteed income riders. This can happen because fees can be complex and sometimes not broken down in simple terms.  For fixed and index annuities, commissions are often built into lower rates or caps and may seem “fee-free” even though they are not.

• Not understanding surrender charges and liquidity limitations. Annuity buyers sometimes forget that withdrawing more than the allowed penalty-fee period – typically 10% annually – triggers steep penalties. This a hard limit – and all you need to know on this topic.

• Not shopping adequately. Some annuity purchasers, especially first timers, buy the first annuity recommended to them or only consider products from one insurance company. This usually happens among those who purchase an annuity directly from an insurance company in hopes they might get a marginally better price. Many of these consumers are unaware that many annuities in the same domain are better than others. Some buyers don’t appreciate that comparison shopping is crucial, or trust a sole advisor too readily.

• Focusing only on “bonus rates” or introductory offers.  While some of these deals are genuine, others are not, often because some annuity agents aren’t inclined to talk about embedded commissions unless they are asked about them. Moreover, some customers are swayed by bonus rates and initial high caps that often reset lower after one year or a few years. Not all agents address this, prompting buyers to overestimate their long-term returns. 

• Not checking the financial strength of the issuing insurance company. Often, but not always, annuity brokers automatically divulge the strength of an annuity rating researched by credit rating agencies – rated at B-, B, B+, B++, A-, A+ and A++ and AAA.  If a broker doesn’t readily divulge the rating, he or she needs to ask.  An annuity purchaser shouldn’t buy an annuity rated lower than B+. Some pundits say the rating should be at least A-. 

• Buying an annuity that doesn’t fit financial goals. Prospective buyers are often wise not to purchase a variable annuity, for instance, because its fees are markedly higher than most other types of annuities. In addition, unlike fixed and structured annuities, they offer no downside protection.  Some years can easily to annual losses. In the first decade of the 21^st century, for instance, the so-called “lost decade” meant that the S&P 500 lost one percentage point even after reinvestment of dividends. If it happened once, it can happen again.

Another step annuity buyers should take

Let’s turn to another meaningful suggestion, especially for new annuity buyers. It’s also wise before purchasing a specific annuity type to know which are among the best annuities in each domain, such as fixed index annuities, fixed annuities or structured annuities. These aren’t the only annuities that should be purchased. Rather, they should be a point of comparison when an agent suggests buying a specific annuity instead of one in the same domain you initially prefer after research. This highlights which of these annuities are probably more attractive.

Here are some high-level annuities that pop up often among the leading types of  annuities:

• Fixed annuities, or MYGAs. In a fixed annuity, a buyer pays a lump sum in return for an insurer guarantee for a fixed interest rate for a set period as high as 10 years.  It’s similar to a CD but is issued by an insurance company and is more generous. In addition, unlike a bank CD, its earnings are tax-deferred.
  
  Strong annuities in this domain include Knighthead Life, Wichita National, Fidelity and Guaranty life and MassMutual Ascend. All except MassMutual Ascend stand out for some of the highest rates.  MassMutual is competitive, not outstanding, but has extremely strong financial strength.

• Fixed indexed annuities (FIAs). These offer principal protection and growth linked to a market, such as the S&P 500, with caps and/or participation rates and the guarantee of no loss due to market downturns. They appeal to those who want safety, as well as some upside potential.
  
  Strong annuities in this domain are Allianz, Athene, AIF (American General), American Equity, Lincoln Financial, Global Atlantic and Pacific Life.

• Immediate annuities.  This is an exchange for a lump sum for near-immediate guaranteed income payments that can last for life. These provide longevity insurance and predictable income. This eliminates market risk from your income stream. For retirees, immediate annuities today can offer payout rates between roughly 6.5% and 10.5% depending on age, gender and select payout options.
  
  Strong annuities in this domain are MassMutual, New York Life, Pacific Life, Protective, USAA and Western & Southern.

• Structured annuities.  These have a “buffer” or “floor” for downturns and a “cap” or “participation rate” for gains. They appeal to investors seeking a balance between market growth and defined risk management, offering more upside than FIAs while having less downside exposure than variable annuities, which are similar to stock mutual funds.
  
  Highly regarded structured include Allianz, Lincoln Financial, Nationwide and Fidelity and Guaranty

Important final points

If you shop for an annuity at a wealth management firm, which will typically offer a bigger inventory than competitors, these firms also commonly sell an annuity outside of their “sweet spot” if that is what a prospective client wants. Diversity of annuities is widespread.

Regardless, the upshot of buying any annuity boils down to a core trade-off.  Annuity buyers exchange liquidity and some investment control for various forms of guaranteed security. And, as already cited, select annuities are guaranteed for the rest of your life – a robustness not offered by any other type of investment.