By Brent Pasqua
Annuities generally bring out many emotions for people, including financial advisors. Many people do not understand annuities, some are immediately turned off by them, and others believe they are just bad altogether.
The truth is that not all annuities are created equal. There is the good, the bad, and the ugly. Unfortunately, most of them are the ugly, and they’re the ones people usually put their money into.
A Common Sales Pitch
Fixed-index annuity sales have soared over the last two decades due to the commissions that insurance companies pay agents for selling the contracts. The amount of commission an insurance agent receives can exceed 10%. The average annuity I see typically pays the agent 7%.
Let’s do some quick math: If you put $500,000 of your retirement savings in an annuity, that means the agent is going to make $35,000 off you.
This is a sales process used by many “advisors” across the country and is widely used in your standard dinner seminar setting. Now that COVID-19 is here, many people will have a break from those trashy mailers. However, once this crisis is over, you might be hit with tons of these invitations. Many of these agents/advisors will be champing at the bit to move your money to an annuity.
A Decision That Can Hurt You
Buying an annuity could end up being a decision that has a tremendous negative impact on your future. Let’s say you are recently retired or laid off from your employer and find your 401(k) still at a much lesser value then it was before the markets dropped. Currently, commissioned indexed annuities that are tracking the S&P 500 have cap rates around 2–4% (depending on the annuity). This means that the most you can make in any given year is up to the cap.
It gets worse: In most of these annuities, you are locking your money into a 10-year contract with very minimal liquidity. Along with that lock, the insurance company can lower your cap at any point it desires. That’s right: Your cap rates are not locked in, which means they can reduce how much you can make whenever they want.
What is even worse is that you cannot take your money out even when they drop their rates. You are locked in.
The market went down by 34.7% in 1937 and went down 36.7% in 2008. However, in 1938, the market went up 28.2%, and in 2009, the market was up 28.8%. If you had left your money in the market for the recovery, you would have been back up to your current portfolio levels within approximately two years.
If you had moved your money at the end of the year into an annuity with the same caps, you would have made only 4%. If you had made the mistake of moving your money to an annuity, you would have never recovered over the life of your contract.
Don’t Give in to Fear
During times like these, we may be fearful of the unknown. However, do not fall for the annuity sales pitch. Agents set up their entire presentations, both at the dinner seminars and when you meet with them, to create fear-based thoughts about losing your money.
The reality is, the one making the most out of the deal is the agent. Consider that their commission can be anywhere from 6% to 8%. This means that if you put $100,000 into the annuity, they can make as much as $8,000—enough to pay for that dinner seminar and have plenty of money left over.
Annuities Have Their Place
I am not anti-annuity. I think there are annuities that are great for specific situations. However, what I am against is commission annuities. The only person who benefits from a commission annuity is the person selling it to you.
Do not fall for the trap, even more so in a time like this.
There are a few good annuities out there, but usually, you can only get them from a fee-only advisor since there are no commissions paid to the advisor. Rolling money over to a commission-based annuity could literally impact the rest of your life, and not for the better.