In this article, we will discuss why investing in annuities and life insurance gets such bad press, and in my opinion, why they deserve it. There are 2 basic types of annuities — fixed annuities and variable annuities. 

The High Fees and Penalties of Annuities

Fixed annuities pay interest and do not fluctuate in value. There is usually a guaranteed minimum interest rate. You are required to hold them for a certain term. If you close the account early there are substantial penalties. These accounts offer tax benefits and drawbacks. While the account is open, the interest is tax-deferred, however, when the interest is withdrawn it is taxed as income, not capital gain. In my opinion, the higher tax rate offsets the benefit of deferred tax. A zero coupon bond offers a similar tax deferral but is taxed at capital gain rates. These types of bonds do fluctuate in value, so you’ll want to have a conversation with us before buying one. 

Variable annuities are all different, but here are some facts. 

  1. All withdrawals are taxed as ordinary income, which is your highest possible tax rate. This is true even if the investments were held long-term or were dividends, which are usually taxed at a lower rate. This higher tax rate is also paid if an annuity is inherited. Annuities do not receive a step up in cost basis when the owner dies either. Stocks, bonds, and ETFs do. 

  1. The investments inside them are usually mutual funds, but often are what is known as an “annuity share,” this allows the insurance company to attach another hidden fee. In a recent article, we wrote we discussed Vanguard’s estimate that the average mutual funds’ fees and costs are already 3.02%. Annuity shares charge those fees and tack on another without providing any benefit for the additional fee. 

  1. “Riders” are another fee you pay in an annuity in the form of insurance on the investments within the account. They can guarantee things like a minimum payout at death or income for a period. These riders each have their own cost and are not cheap. Unfortunately, people often don’t realize that a “benefit amount” on an annuity is often only valid if you take income over a period of 10 or 20 years, and in many cases life. That means that you can’t cash your investment in as a lump sum without losing these benefits 

  1. If you close an annuity early the penalties are often as high as 10%  

  1. The commission on the sale of an annuity is often 8%. This is amongst the highest in the industry. Not surprisingly, high-commission investments attract a certain type of people to sell them. Getting honest information about annuities can be tough.  

At the end of the day, you have to evaluate each investment against your personal situation, but with disclosed and hidden fees often as high as 10% per year, 83rd Street does not and will not sell annuities.

What about Whole Life, Universal Life, Variable Life Variable Universal Life? Are they different than annuities? 

When I was 24 my State Farm agent got to know me well. I was one of his favorite people. I, an unmarried male under the age of 25 and had just bought a Trans Am. We’ve become good friends over the last few decades. He once told me something that stuck. “You only buy insurance to replace the things you cannot afford to replace without it.”     

Alternatives to Annuities and Life Insurance

In my opinion, the insurance policies named above are not good for the investor, they are good for the salesperson. They, like annuities, offer ridiculous fees, hard-to-understand benefits, and some slick salespeople. 

If you need insurance, term policies offer insurance at clear rates without many tricks.   

If you want your investments to pay for your insurance, you should open an account and invest in indexes and pay your premiums from that account. You will save yourself substantially in fees. 

Making Informed Decisions About Your Finances

Before making the 8-10 year commitment to an annuity or insurance policy, get in touch with our team. We’ll show you all the things hidden in the paperwork that the salesperson didn’t.