Annuities are a great financial tool for many people, yet don’t belong in the portfolio of some others. Unfortunately, there are some incorrect arguments against these products circulating that might keep consumers away who could really benefit from the safety and guarantees of annuity products. In Life Health Pro, John L. Olsen and Michael E. Kitces give us “5 arguments against annuities – and how to overcome them.” These arguments often don’t take important details into consideration and instead give a blanket statement for products whose complexities must be understood before making a decision about using them in your financial plan.
The first argument that people love to make against annuities is that they are too expensive. But the problem with this argument is that when making comparisons with deferred variable annuities, they aren’t usually apples to apples comparisons. Annuities are insurance products, but are often compared with investments that don’t offer the same type of guarantees. Death benefit guarantees and tax benefits are overlooked when comparing the investment returns and liquidation of variable annuities versus mutual funds. No-load mutual funds don’t charge commissions because you aren’t getting any type of financial advice, so comparing these to a commissioned variable annuity is just unfair. With the variable annuity, you are receiving great value from the initial asset allocation through the continual servicing and re-balancing.
Annuities are often touted as being too complex and they certainly can be. Both variable annuities with guaranteed minimum income benefits (GMIB) and fixed equity indexed annuities have detailed contracts that must be fully understood by both consumers and their advisors. Some advisors sell 6% or 7% guarantees without offering the added details to the returns. Many of those advisors don’t even understand the details themselves. But the majority of contracts are not impossible to understand if advisors take the time to learn the details and then pass those details onto their clients. Guaranteed living benefit descriptions and equity indexed annuity formulas can be tricky, so make sure that your advisor has taken all available training courses and can explain the details of the annuity to you. These annuities bring great value to many consumers as long as they are understood and used in the right portfolio.
Three arguments are often used to say that annuities shouldn’t be used in the funding of IRAs or qualified plans. They almost always use variable deferred annuities in these arguments and ignore the fact that there are immediate and fixed annuities as well. But even so, those who say that you are paying for tax deferral and not getting it are just wrong. The annuity may not offer additional tax deferral that other money doesn’t offer as well, but you are still getting the same tax deferral. You also are not paying for any tax deferral with your annuity. You are paying for insurance guarantees. Many people say that the tax deferral used in funding an IRA with an annuity is actually wasted. This is not true because non-qualified annuity tax deferral doesn’t even apply to IRA annuities and the overall assumption is just irrelevant. Overall, the argument against annuities being too expensive of a choice is based on whether or not you need the insurance guarantees. Certainly if you don’t have use for the guarantees and death benefits, you should not pay for them. But if those benefits offer you value, they may be worth the cost.
Some people argue that annuities are only sold because they pay high commissions to those selling them. Once in awhile, that could be true, but that statement is typically based on false assumptions. Any investment’s benefit should be based on what you get for it, not just what you pay for it. Costs may be higher with a deferred annuity than they are with a mutual fund, but the benefits your receive may be better as well. There are also annuities that are low-load or even no-load, so they do not charge as much and pay no commissions. The benefits they offer are also lessened. Take into account the guarantees you are receiving and compare that with the costs you are paying. The costs versus the benefits should be the only thing you consider when deciding if the commissions paid are “too much.”
A very low, like 2% or so, percentage of deferred annuities are ever actually annuitized. That is what the argument is at least. The so-called statistic used to measure this is just unreliable first of all. The actual definition of annuitization being used does not actually reflect the amount of people who convert the accumulated value of their annuity into an income stream. And even if it did, your choice to annuitize is there, even if you choose not to for whatever reason. People are getting lifetime income out of their deferred annuities at a much greater rate than 2%. Some opt to transfer their deferred annuity to a SPIA to get a higher annuity payout rate. That 2% figure just doesn’t accurately depict what is happening in real life.
Whether an annuity is right for you or not is a complicated decision that should be made based on accurate information and help from a professional in most cases. This article and blog are not meant to say that you should definitely purchase an annuity. These arguments against them are simply not valid and you should base your choice on information and whether or not the benefits you would receive are worth the costs that you would pay.
Written by Rachel Summit
