by Ben Johnson
That sure sounds nice, especially in times like these where uncertainty in both the stock and bond market runs high. However, as with most things that sound too good to be true, it is not quite that simple. If someone is offering you 8% today, you know it’s not as simple as it sounds. How are they able to give me that return? How are they making up the 6% to 8% commission paid to the Advisor (sales person)? It’s done by fees inside the contract, surrender charges to ensure the contract stays with the company for many years, the cost of riders guaranteeing income, death benefits etc..
Have you ever gone to buy a car for say $40,000? Then when you go to complete the purchase, the dealer suggests (FOR YOUR PROTECTION) you get the 6-year Bumper to Bumper EXTENDED warranty, and also the anti-theft devices, nitrogen in tires, window tinting, chrome-plated wheels, all-season floor mats, splash guards, wheel locks, cargo trays and alarm systems. You walk out of the dealership spending $50,000 — “How did that happen”? It sounded good, I guess I ’m protected? Did I really need all that?
This can happen in investments too. The graphs and promises often used to illustrate guaranteed income products seem clear and straightforward, but the reality is that these contracts are often highly complex, inflexible, confusing to the average investor, and often misunderstood. Many investors enter the world of annuities, which is the source of most guaranteed income products, as a way to eliminate some level of risk that is often associated with investing. Over time however, the perceived benefits of guarantees often don’t meet expectations, leaving many investors feeling frustrated, misled, and angry. When rent, cost of medical care and food prices goes up, the guaranteed income you signed up for doesn’t. A guaranteed death benefit feels good, but the cost of personalizing your benefits is coming out of your actual account balance.
A “Fixed Annuity” offering lifetime payouts can provide a comforting solution. But have you asked all the questions you should? Will it meet my needs if inflation gets high, how strong is the company that guarantees it, can I get out if I need to? Increasingly we want “full disclosure” in what we buy, and whether disclosed or not, I find few investors understand what they are buying.
Newer annuity products promise a specific “guaranteed” annual return, say 6%-8% until you start taking income. This return is not yours to take in lump sums or pass on to heirs. Heirs get the actual balance which is reduced by the distributions and the annual cost of the Income Guarantee Rider. The “guaranteed income for life” sure sounds appealing, but if you instead choose to use traditional Bond Ladders and stocks or generic Systemic Withdrawal Option, available in most annuities or without a fee, you may receive a higher monthly payout option, earn a current, real-life rate of return and retain control over the distribution of your entire account.
KEY TAKEAWAYS on “Guaranteed Income”
- Potential for lifetime income stream: Annuities can provide a reliable income stream in retirement, but if you die too soon, you may not get your money’s worth. Once you “annuitize” your annuity, or if you buy an immediate annuity, your lump sum can be turned into a series of payments that will be promised for your life. The insurance company is responsible for paying the income it has promised, regardless of how long the annuity owner lives; however, that promise is only as good as the insurance company behind it. This is one reason investors should only do business with insurers that receive high ratings for financial strength from the major independent ratings agencies.
- Riders can customize an annuity to fit your needs but be aware of Fees: Death Benefits and Guarantees are appealing, but annuities often have high fees compared to mutual funds, Treasury Bonds, ETFs and other investments. The cost of an annuity is as high as 3.8% annually or higher with riders. This can eat away at your return. Many contracts also carry a surrender fee for years, making it difficult to leave. Feeling trapped is no way to invest.
- Money Management is left to someone else for investors who’d rather leave that work to someone else. The question is should it be an Annuity (Insurance company) or an Registered Investment Advisor who has the fiduciary responsibility to work in your best interest at low fees.
There are many low-risk ways to grow your savings and secure an income. Various types of annuities are among them, but understand your options and what they mean. At Yes Wealth Management, we have access to the entire market of investment options. It is our goal here to ensure that our clients know the “why” and the “how” behind their investment choices and what is best for them.
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