Surrender Fees Are Not a Big Deal

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This one is sure to hit home with a few critics but there’s an important lesson here.  Surrender fees are probably the biggest negative that come with annuities.  Since most other investments have nothing like it, declining fees over the years are new to everyone who is a first-time user.  There is a reason they exist and several reasons why it doesn’t make a difference for the average person with an annuity.

Most of you have been saving into retirement plans and accounts for 30 years or more without ever touching the funds.  So what’s wrong with being able to pull 10% each year from an account penalty free?  Plus for portfolios with a long-term objective, it’s not common to move more than 10% of a single account for rebalancing or any other adjustments, especially while in retirement when you should be focused on other, less stressful things.

While some may think it’s a raw deal to have money held hostage by a large fee on the back end, others understand how it works and it doesn’t bother them.  Most of my clients who have had annuities for several years have never touched the account.  For those it’s just safe money without fees and some good growth on top of it.  No cares or worries at all…

Those are just a couple of the ways I’ve always explained it but I’m not sure it resonates.  It’s justified to want a better explanation for how commissions and state premium taxes affect the contract and there is more to it.  Consider that the insurance company invests in long-term bonds to back an annuity.  If you bail out early the company would have to sell assets in a potentially unfavorable environment.  Within an annuity, the insurance company bears the interest rate risk which is one of the primary threats of income planning.  The fact that you can get 10% per year without fees, penalty or risk of loss is actually a pretty good deal.

Well aside from the mechanics there are some other reasons that might make sense.  Two things I’ve seen consistently over the years actually give you more control over the outcome.  The first is the fact that most index annuities have growth in the first few years that exceeds the surrender fee.  The account goes up and the fees decline meaning a person could walk away with more than the initial investment.  This is the point where most realize they have a pretty good deal.  Because they realize it’s a good deal, no one walks away.

The second one is something I have mentioned in passing for several years.  I always told people that you can maximize the withdrawal from a potential contract and get a substantial amount of money out of it before the surrender period ends.  I was recently running numbers on an income scenario for one couple.  We thought about maximum withdrawals so retirement income could be combined with Roth conversions in the first ten years of retirement.

I looked at the illustration and did some basic math.  At the guaranteed minimum, meaning no growth in the account, this couple could maximize free withdrawals each year and at the end of ten years would have drained more than 68% of the initial contract value.  If consistent growth of 4% is achieved the withdrawals would be bigger and amount to almost 80% of the initial value plus leaving behind an even larger remainder value.

Take a second and think about how big a change you’d need to make in order to shift +/- 70% of an account over the first then years of retirement.  If you end up with an annuity you don’t like then don’t just sit there.  Doing nothing is the worst thing.  Or maybe you should just start with a good one.  There’s all sorts of opportunity with that kind of liquidity on safe assets.  I showed you all an example last week of what can happen using withdrawals and incremental investments.  There’s a link to last week’s video near the bottom if you missed it.

There are all sorts of examples and ways to improve an annuity.  Eliminate fees and use the protection and liquidity to your advantage.  Yes, I make money if you buy an annuity from me but I don’t make money for writing this letter every week.  You may have a surrender fee on the annuity but my advice is free.  As long as you get a plan that works then I’d say it’s a pretty cost effective way to plan for retirement.  All things consider, surrender fees are really not a big deal.

Enjoy your weekend…

Bryan

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