“Did I do OK?” Milly asked, as she showed me her two-month-old annuity policy. She had purchased an annuity with fifteen years of level surrender charges! I could not believe my eyes, and looked twice to make sure I was reading it correctly. She was stuck. The best thing she could do now was to invest the rest of her money to working harder, or pay the penalties and call it “investment tuition.”
Here we are in the twenty-first century and smart college degreed investors still do not know how to obtain financial peace of mind, but instead purchase inappropriate investments. It is time for investors to seek the truth in all areas of investing, including annuities with penalties. How likely is it that investors, not just Milly, will not change their minds in the next fifteen years? If she takes out any money the first fifteen years, Milly will be trapped and suffer a fifteen percent penalty! This is investor abuse and should be outlawed.
It’s the old story: Knowledge is power. And to be a successful investor you need to know the truth and act on it. First, you must unlearn bad information, so your mind will be open to new ideas. Then you can learn the right questions to ask. Here are some basics on annuities.
An annuity is an insurance policy that allows you to have money until you die. Your money grows tax-deferred, and is taxed at your income rate when you take distributions. There are no IRS early redemption penalties after the annuity’s owner is age 59½. A retail/commercial annuity will have its own penalties that are determined by the insurance company writing the policy.
There are two basic types of annuities: fixed and variable. A fixed annuity typically invests in bond portfolios for income, and the variable annuity invests in mutual funds for growth. If you believe the economy is going to go backwards for the rest of your life, then consider a fixed annuity as you believe there will be no inflation. However if you feel the economy and inflation are going to continue in their random manner, then consider the variable annuity.
Because we believe in the random growth of the free market, we will only discuss the variable annuity in this article. Here are a couple of truths you need to know to protect yourself from abusive annuities.
1. Annuity penalties are optional. STOP purchasing annuities with penalties! If your annuity no longer has a penalty and your investments are not doing well, you would be smart to do a tax-free transfer of your money to a non-penalty annuity. But the first insurance company would not be happy, as it could no longer make money off your money. It’s all about the bottom line. You see, the larger the penalties and the more years they last, the larger the commission your financial planner earns and the more money the insurance company keeps. For Milly, the fifteen years of penalties guarantees the insurance company will make money off her annuity, whether she keeps her policy or not. This is abusive.
2. There are more expenses hidden within the annuity. The larger the expenses, the more money the insurance company makes. One of the areas of concern that results in redundant costs to the investor is stock duplication within the annuity’s mutual fund options. It makes no sense to have one mutual fund manager buying PepsiCo stock while another is selling PepsiCo. You, the investor, are paying all of these costs, for both the buys and the sells, called turnover. An annuity, which holds retail/commercial mutual funds, is not putting you first. It’s a win-win for the financial planner and the insurance company, but not for you the investor. You must pay these costs, whether your annuity gains in value or not.
You need a win-win-win, where everyone wins—including you! The right annuity could be an excellent investment strategy. When talking to your advisor, ask for a fee variable annuity, which has institutional asset class mutual fund options. This passive investment strategy has extremely low mortality and investment costs, plus the annual fee is tax deductible. The fee annuity has no front load, no back load, and no surrender charges or penalties. As long as you are more than 59½ years of age, your money could go in and come out any time, without charge. If you don’t feel your investments are keeping up with the market, you can leave the annuity without any penalty.
Do not fall into the abusive annuity trap. If you have just purchased an annuity with a long surrender charge and high penalties, and you are still in your “free look” period, immediately send your policy back to the company. Help these policies go out of existence. Do not buy them!
Written by: Maria J. Wordhouse Kuitula and Phyllis J. Veltman Wordhouse, free market wealth and stewardship coaches, co-authored the book Stress-Free Investing, available at Amazon.com. Maria is the president of Wordhouse Wealth Coaching and may be reached at 616-460-6518 or at [email protected]. For QUESTION LISTS and INVESTOR EDUCATION VIDEOS, go to www.WordhouseWealthCoaching.com<http://www.wordhousewealthcoaching.com/> . © Wordhouse Kuitula 2013. Photo: stock.xchng