Clear Direction for Your Retirement: Annuities: The Good, The Bad, & The Ugly Part 3

In this series, we’re looking at the Good, the Bad and the Ugly about annuities but in reverse

order. We covered the “Ugly” in our previous article, this month we’ll look at the “bad” inside the annuity world.

I have stated previously the need for making financial decisions and especially financial product decisions without blinders. That means being educated transparently and fairly about the product at hand and by someone who is required to do so, namely, a fiduciary who has your best interest in mind. Further-more, the decision should be based within the context of a broader financial plan that is unique to you. Bad experiences with any finan-cial product are typically due to a lack of the aforementioned items as well as the advisor not setting proper expectations with the client. 

In fairness of disclosure, I do believe some annuity products are a better alternative as compared to others given the goals needed but at the core of the issue, I believe inves-tors should have the choice and freedom to utilize the product they believe is best for their situation but be educated about the pros and cons of said choice. Additionally, annuities are not appropriate for everyone regardless of the type (Fixed vs Variable – see previous articles or below for definitions).

The Bad

Now, it is here that I want to introduce the 

“Bad” in the annuity world – illiquidity, surren-der charges and market value adjustment. Ac-tually, these aren’t really bad per se’, just not well-liked because, as I’ve stated in previous articles, clients are not given proper education and expectations about these areas. Also, a lack of planning will tend to exacerbate prob-lems with these areas should they ever arise as planning should be taking these concerns into account from the outset.

Liquidity

Liquidity is just a fancy word that means your ability to get access to your money,

     so if a financial vehicle is completely liquid, it offers you unrestricted access to your money without penalty. If it’s really illiquid, it doesn’t.

So what about most annuities – whether they’re variable annuities (meaning those tied to the market and its risk), or fixed or tradi-tional annuities (which aren’t tied to market risk), or fixed index annuities (which are simply linked to a market index’s performance but aren’t exposed to market risk)? What do the majority of these all offer when it comes to liquidity or access to your money? Well, they do have limitations, but generally speaking, the majority of them allow what’s known as 10% free withdrawals (without surrender charge) 

– or access to up to 10% of your money –starting after the first year. Some even allow it within the first year if needed.

Now, this can feel like a real restriction, right?Not necessarily. If you’ve planned appropriately, you should have additional and adequate liquidity in other areas (not in an annuity) and the 10% free withdrawal is simply the gravy on the potatoes if ever needed. However, some-times emergencies arise, unforeseen issues like health emergencies, what about those situations? Let’s review this in light of early withdrawal penalties (surrender charges).

Surrender Charges / Market Value Adjustment (MVA)

Surrender Charges are directly tied to the question of liquidity within an annuity contract. If you follow the rules of the contract’s liquidity features, you’ll never have an issue. Even still, these charges can be quite steep. On a 10 year contract they may start around 9% and reduce annually until after the final year where they are at zero. Ouch!

 The thing to keep in mind is that the surrender charge never comes into play unless more is pulled from the contract than is allowed during the surrender charge period (and these can vary but are typically 5-10 years). If you pull more than is allowed (even if it’s partial and not the entire contract value), the entire withdrawal is subject to surrender charge and some con-tracts may also carry an MVA charge to adjust for interest rate movement since the contract was originally purchased. This MVA can be positive or negative to you in terms of dollars depending how rates have moved.  

So what happens when the emergency we referenced above happens and 10% just isn’t enough? Well, most insurers have already compensated for these type of events for contract holders. The good news is there is typically an emergency exit for situations like terminal illness, nursing home stays and even death where the insurer waives any penalties and you or your beneficiary has 100% access to the funds.  

So, in some sense, what some see as bad in an annuity is rarely a problem unless the annuity is used in the absence of proper financial planning. To recap this and previous articles thus far, variable annuities are ugly and some features of all annuities can be bad if not properly planned for. Our next installment will look at the good annuity (in my ever so humble opinion).  

I hope this is helpful to your retirement journey. Call us, come see us or visit us at www.woottonfinancial.com, we’d love the opportunity to help address your questions and concerns and provide you Clear Direction for Your Retirement®.

Investment Advisory services offered through Game Plan Advisors, Inc., a registered investment advisor. Insurance services offered through Wootton Financial Group, Inc. Game Plan Advisors, Inc. and Wootton Financial Group, Inc. are affiliated through common ownership. Neither Game Plan Advisors, Inc nor Wootton Financial Group, Inc. offer legal or tax advice. Please consult the appro-priate professional regarding your individual circumstance. Not associated with or endorsed by the Social Security Administration or any other government agency.

Please consider the investment objectives, risks, charges, and expenses carefully before investing in Variable Annuities. The prospectus, which contains this and other information about the variable annuity contract and the underlying investment options, can be obtained from the insurance company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

The investment return and principal value of the variable annuity investment options are not guaranteed. Variable annuity sub-accounts fluctuate with changes in market conditions. The principal may be worth more or less than the original amount invested when the annuity is surrendered.

Fixed Annuities are long term insurance contacts and there is a surrender charge imposed generally during the first

5 to 7 years that you own the annuity contract. Withdrawals prior to age 59-1/2 may result in a 10% IRS tax penalty, in addition to any ordinary income tax. Any guarantees of the annuity are backed by the financial strength of the underlying insurance company.

Indexed annuities are insurance contracts that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company. Surrender charges apply if not held to the end of the term. With-drawals are taxed as ordinary income and, if taken prior to 59 ½, a 10% federal tax penalty.  Investors are cautioned to carefully review an indexed annuity for its features, costs, risks, and how the variables are calculated.