Annuities are not bad. But abusive or naïve agents can lead to real trouble.
If you are considering the use of an annuity for retirement, there is nothing to be scared of. Save your anxiety for the real problems retirees face like the longevity of social security and Medicare benefits. Choosing an annuity as a retirement investment vehicle is a science.
First of all, suitability for the intended purchaser needs to be determined based on a wide variety of factors unique to each individual.
Then comes product selection. After surviving the suitability process, screening products can seem like a daunting challenge. And, in a lot of ways, it is. The selection process is where greedy salespeople make their move. The purchase of any annuity will pay someone a commission, so you need to get over the fact that an agent is looking to make money. That’s just the way it is. Concentrate on your needs and you’ll be fine.
Here is a quick list of the things to look for so you can avoid the purchase of an inferior product.
Surrender Charges- Most deferred annuities have no upfront fees so the insurance company protects themselves by charging you for canceling your contract early. Longer surrender schedules indicate a higher cost to the company. Most of the time this is linked to upfront bonuses and higher than average agent commissions. Your best interests are not being represented. Simply ignore products with surrender schedules that last more than seven years.
Some decent products have longer schedules but there needs to be a compelling reason to extend the contract. Do your homework! On a side note, make sure you clearly understand any additional restrictions placed on the surrender of a contract. Some contracts state that you can only surrender early if you take installments over a certain period. Also, those same contracts will impose those restrictions on your heirs should you pass away before the schedule expires. Avoid any such contract at all costs. There is no academic benefit to annuities like this. It’s your money and you should maintain as much control as possible.
Interest Rates- An individual must learn to analyze the interest rate components of a contract. Important rates to know about are premium bonuses, guaranteed minimums and the yield to surrender.
Premium Bonuses – Many companies lure investors with lucrative one-time bonuses. These almost never work out to your benefit. This raises the cost of placement for the company and leads usually leads to a longer surrender schedule. Don’t let the sirens lure you in. Turn around and walk the other way.
Guaranteed Minimums- This rate tells you how much interest you will make in the worst-case scenario. Don’t settle for less than 3%. If a company pays less than that, it will indicate one of two things. Either they are trying to cut costs or they don’t have a clear enough picture of their future financial performance. You want solid companies that have survived the 2008 financial storm and expect to do business as usual now and in the future. Your money deserves no less than the best.
Yield to Surrender- This is the cumulative rate of return you can expect when the contract expires. This is where the useless bonus rate is exposed and a solid minimum guarantee shines through. Bonus rates likely lose ground over time and a good minimum guarantee will provide you with reasonable expectations.
Credit Ratings- Annuities are supposed to be a safe investment. It should go without saying that you want to place your money with the most stable company you can find. Turmoil in any atmosphere will weed out the weakest players and further strengthen the most stable. Find those companies. They deserve to be trusted.
To keep things simple, we can stop right there. Those areas are exactly where you will run into trouble. Captive agents have little choice but to sell specific products and commission motivated agents will often overlook many potential pitfalls. Understand the ground rules and learn the basics and you have nothing to worry about. Remember, it’s just an annuity… there’s nothing to be scared of.