I’m a Financial Advisor: 3 Reasons To Avoid an Annuity
Written by
Marc Guberti
Edited by
Zuri Anderson
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Annuities are financial products that give you a steady income stream when you retire.
You can contribute to these insurance products with tax-free dollars and then pay taxes when you receive money from the annuity. It’s like a traditional 401(k) plan and Social Security wrapped into a single product, but not every financial advisor likes annuities.
Marc Lichtenfeld, the chief income strategist at The Oxford Club, is one of the financial advisors who steers clear of annuities. He shared three reasons why people may want to consider other financial products for funding their retirement.
Fees and Commissions Add Up
While the thought of receiving monthly payments from an insurance company sounds appealing, you have to invest a lot of money into an annuity for those monthly payments to be meaningful. Insurers also don’t give money out of the kindness of their hearts, and given the sizes of some of these companies’ headquarters, it’s easy to tell that they often profit from their products at other people’s expense.
“There is no such thing as a free lunch,” Lichtenfeld said. “Insurance companies that sell annuities don’t just give money away. They make money on your money, which suggests you could do better investing it yourself without paying high fees and commissions. Depending on the annuity, you’ll pay anywhere from 1% to 8%. At the midpoint, that means if you have $100,000 to put into an annuity and are paying $4,500 in fees and commissions, only $95,500 is being invested.”
Lichtenfeld’s description highlights how people can lose money twice with annuities. High fees and commissions are one way, but you also lose the opportunity cost of putting your money into an asset like an S&P 500 index fund.
Granted, annuities are more beneficial than putting your money into speculative options trades where it can all be wiped out, but most people who are considering annuities aren’t even entertaining those types of speculative trades.
You Get Locked In
An annuity isn’t like a checking account that lets you take out money at any time. Some annuities are very complicated, depending on the insurer. There are penalties that come with early withdrawals, and they can impact your monthly payments.
“Annuities are complicated and lock you in,” Lichtenfeld said. “If you have a family emergency and need the money earlier than expected, you’ll pay dearly for access to it. Most investors and many advisors don’t understand all of the clauses in the contract.”
If you want to set up an annuity, make sure you have enough money in your savings account to cover emergency expenses. It’s also good to have enough money to cover six to 12 months of living expenses before you consider setting up an annuity. Having an emergency fund is a good practice, in general, even if you have no interest in annuities.
Changes To Annuity Recommendations In 2018 Tell The Story
Lichtenfeld said that consumers should look at how key law changes for financial advisors in 2016 and 2018 affected annuity sales. He views it as a central reason to avoid annuities.
“Here is everything you need to know about annuities. In 2016, the Department of Labor passed a rule that all financial advisors would serve as fiduciaries. Once the rule was passed (not implemented), annuity sales fell 8%. Sales of variable annuities, which are the worst kind of annuity, plummeted 22%. As soon as advisors saw that they could get in trouble for selling these investments, they stopped,” Lichtenfeld explained.
“In 2018, the [Donald] Trump administration killed the rule, and annuity sales spiked 40%. In other words, once the consequences were removed for selling these expensive products, advisors pushed them hard,” he concluded.
Fiduciaries are required to serve in their clients’ best interests and can get in trouble if they recommend financial products that don’t align with their clients’ long-term goals. Lichtenfeld said that the thought of every advisor becoming a fiduciary by law caused a slowdown in annuity sales. One that fear was gone, sales ramped up again. The pattern of annuity sales from 2016 to 2018, as connected to policies, suggests that these financial products aren’t the best.
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