Shopping for an Annuity? It’s Important to Avoid Mistakes

Annuities are selling in record numbers because they make a lot of sense for near-retirees and retirees. After all, they essentially grow funds, in some cases handsomely, in impunity. Still, some perspective is in order. Their strengths notwithstanding, annuities are not for some folks, they should not overwhelm other financial investments, and the annuity they’re eyeing shouldn’t be purchased before some research and contemplation.

In addition, if you decide that an annuity is probably a good fit for you, you have to ask about different types of annuities and determine those best for you, bearing in mind that the biggest single reason to buy an annuity or annuities is to make sure you don’t run short of money in retirement. You cannot say this about the stock market and, given some negative developments in recent years, perhaps not about the bond market, either. This is the biggest reason why select annuities provided by financially strong insurance companies are attractive.

Predictably, a good number of folks know what they’re doing before purchasing an annuity. But many more aren’t sufficiently up to the task. After all, how much would a typical annuity novice really know about annuities?

Unfortunately, this leads to annuity purchase mistakes that can easily undermine an annuity owner’s financial situation in later years. One of many mistakes made by novice annuity buyers is to buy an annuity and then, after a couple of years or so, bail out because he or she discovered a more enticing annuity they preferred. If they sell the first annuity and buy the new one, this almost always works out poorly because our hypothetical buyer has to pay a sizable surrender fee to make the switch – something too costly to come out on top.

Given this and other troubling situations, here are common mistakes that should be avoided when buying an annuity.

• Not making an effort to consider an annuity. When contemplating an annuity, it’s easy to become overwhelmed with the various types and payout options and other assorted details.  This can quickly lead some to avoid annuities altogether.  Yet an annuity can be an excellent addition to your financial portfolio. It can provide guaranteed lifetime income, safety from market volatility and tax advantages.  If you want simplicity, you could just buy a plan vanilla fixed annuity, which is much like a bank CD but much more generous.

• Not asking the right questions before buying.  Answers to questions are crucial to selecting the right annuity for you.  What type of annuity? Are there fees? How much are surrender charges?  How much can you withdraw annually penalty-free?  How long is the rate guaranteed?  How long is the contract term?  If they have annuity renewal rates, are they likely to be relatively competitive? (Most annuity companies change the credit rate for index annuities periodically.)
  
  If your broker confronts you with lots of industry jargon, sometimes making it difficult to determine which questions to ask, move to another firm, regardless if the broker offers a seemingly great deal. Ultimately, it’s typically not as good as it sounds.

• Strenuously avoid choosing the wrong annuity. Choosing the wrong annuity can result, among other things, in high fees and poor returns.  If you purchase an annuity with excessive fees or a long surrender period, for instance, you may lose a significant portion of your investment if you need to withdraw early.  There is no  one-size-fits-all annuity on the market, although some sales folks present it in this  way.  In reality, different types of annuities accomplish different goals, depending upon what you’re trying to achieve.
  
  With each choice comes pros and cons.  The aforementioned fixed annuity for example, is super-simple and generous in comparison to a CD.  But there is a con: There is no inflation protection, something to think about in a multi-year investment. (This is true regarding CDs as well).

• Don’t invest solely in annuities.  Because annuities are illiquid, due to surrender charges, you should never invest more than 35 to 40% of your financial assets.  This could be a big problem if life takes an unexpected twist. And if you ultimately buy more than one annuity, it’s best to invest in a different insurance company.  Insurance companies that sell annuities rarely run into financial issues. Still, putting all your eggs in one basket could conceivably expose you to the financial risk of one insurance company. (Many advisers recommend choosing annuities from insurers rated A or better.)
  
  Generally, prospective annuity buyers are best off working with an independent financial advisory firm.  “”Independents,” by definition, implies not being tied to a single company.  This allows them to shop around and offer prospective clients a wider range of options.

• Pay attention to fees to the extent you can. Commissions paid to the sale of an annuity come from the insurance company, not you. Still, some annuities charge additional fees.  There are also additional fees imbedded in annuities, such as surrender charges, although they are virtually universal and cannot be sidestepped.  In addition, if you’re interested in buying a fixed annuity, make a point of fully understanding the interest rate.  Many annuity contracts offer both a minimum guaranteed interest rate and a higher current interest rate.  Focus on the former, not the latter, and make sure it is competitive with other players in the market. (Most fixed annuities typically beat the minimum, but it shouldn’t be ignored).

• A married couple, in general, should make a point to name their spouse as a beneficiary. This might seem obvious, but not doing so is a common mistake, partly because some annuity brokers don’t explain this sufficiently.  If this isn’t set up and the spouse that bought the annuity dies, the other spouse is only guaranteed income until the remaining investment has been depleted.  By contrast, when the spouse is named as the beneficiary, payments will continue as they were before the other spouse’s death.

In some cases, one of the two married couples know the importance of a spouse beneficiary but still ignore it.  Some couples maintain separate financial lives, and one spouse might have specific estate planning goals that don’t involve the other, such as, for example, preferring to leave assets to children from a previous marriage.  If they know what they are doing, this is the couple’s business. They just have to make sure they’re comfortable with this.

The upshot on all these points is that it pays to be knowledgeable about the annuity world, which starts with plenty of primers on the internet.  Prospective annuity buyers should also clearly decide what type of annuity they really want and why. Lastly, they should make sure that the financial firm they deal with knows which insurance company or companies offer the best deal for their particular situation.  If the firm seems to comes up short, they should keep shopping elsewhere.