By Boyce F. Lowery, CLU, ChFC
This is the first article in a series of articles about annuities. There is much to address—far too much for one article.
Let’s start with this fact. Annuities have a pretty bad reputation in some circles. In fact, one popular leader in the finance arena continually broadcasts how much he hates annuities. Now, “hate” is a pretty strong word for something as inanimate as a financial product.
That’s all an annuity is, a financial product. It is a contract with an insurance company that can be used for accumulation of funds on a tax-deferred basis (a deferred annuity) or to provide a stream of periodic payments over some time frame with the income commencing immediately (an immediate annuity). Some other annuities include an income rider and are designed to have a period of accumulation with deferral of taxes before income commences at some point in the future at the discretion of the annuity owner.
So, why are some people afraid of annuities? What is it about annuities that makes some advisors and consumers run in the opposite direction?
A Potential Conflict of Interest
One issue that deters some financial advisors from recommending annuities is a potential conflict of interest. Many financial advisors are paid fees based on a percentage of assets under management. Assets under management (AUM) is the money that the financial advisor invests and manages for his or her client, and fees are charged to the client as a percentage of those assets under management.
An annuity generally does not count toward AUM because it is not managed by an investment advisor, but rather the insurance company. Therefore, financial advisors generally do not collect ongoing fees based on money held in an annuity, though some insurance companies are beginning to compensate advisors annually for dollars held in an annuity. It is in an investment advisor’s personal best interest to keep all of your money invested under his or her management rather than getting paid a one-time commission for the purchase of an annuity— hence the potential conflict of interest.
Advisors commonly charge around 1% of AUM for their services. That means that the difference between investing $500,000 in an annuity and investing it in stocks, bonds, mutual funds, or a managed account is $5,000 a year in fees for the advisor. Where you put the money doesn’t really affect the advisor’s workload, but it greatly impacts their fees. What advisor wouldn’t want an extra $5,000 a year without having to do anything extra for it?
By the way, the reverse potential conflict of interest can be true for commission-based advisors. Some advisors work under a commission-based model and thus have an incentive to make a sale that may or may not be in the client’s best interest.
Thus, the consumer must find an advisor who is an expert in their knowledge of annuities and who will keep the needs of the client uppermost in all financial recommendations.
Lack of Knowledge and Misconceptions
Because there are so many different kinds of annuities available, there is a lot of confusion surrounding them. One of the most popular arguments against annuities is that they have high fees, a common assumption that is perpetuated by people both in and out of the finance industry. However, the truth is that some annuities have no fees whatsoever, while others have fees that are discretionary based on the benefits desired. The client is able to determine if the optional benefit being offered is worth the fee being charged.
Unfortunately, there is a great lack of knowledge regarding how annuities work and how they can benefit people in retirement. Guaranteed income, as provided by an income annuity, can actually help increase one’s retirement income, making it a prudent option that mitigates the fear of running out of money. Some deferred annuities can accumulate and ultimately provide an income that would allow an even greater retirement benefit than would otherwise make sense, all things being considered. Many are aware of “the 4% rule” that some advisors advocate for retirement withdrawals while others feel that amount is a little too risky. Others recommend using the Required Minimum Distribution percentages as a good rule of thumb. Prudent use of annuities can allow a much higher draw-down rate from overall retirement assets than either method mentioned above while guaranteeing lifetime income.
Another reason that some advisors avoid recommending annuities is that they compare them to completely dissimilar options. Many fail to recommend annuities because they simply do not have the growth potential of equities. The fact is that most annuities are not intended and never were intended to mimic returns (or the risks) inherent from an equity portfolio. That’s simply not their purpose. Unless a variable annuity is being utilized, annuities do not have risk of loss from the vagaries of the markets, but they do have guarantees and other features simply not available from other financial options.
The Truth about Annuities
As we’ve addressed, the suitability of annuities for one’s financial portfolio is not as simple and clear-cut as many make it out to be. Annuities are a very useful financial product that can play a vital role in the financial planning for many. They are not right for everyone, but neither are they wrong for everyone.
All financial vehicles have pros and cons. It is important for the consumer and his/her advisor to be knowledgeable and unbiased when making financial decisions rather than simply following popular trends blindly. If you have questions about annuities or want a professional’s perspective of some of the common beliefs surrounding annuities, call us at 888-827-0146 and we at Suncrest Advisors would be happy to answer your questions.
Boyce Lowery is a 40-year veteran and established expert in the insurance industry. As the managing partner of Suncrest Advisors, he, his partner, and their associates all aim to provide financial security and peace of mind to business owners, executives and professionals, and high net-worth individuals across the United States. Along with more than four decades of experience, Boyce is a Chartered Life Underwriter® (the premier designation for insurance professionals signifying specialized knowledge in life insurance and estate planning) and a Chartered Financial Consultant® (known as the advanced financial planning designation). To learn more, visit http://suncrestadvisors.com/ or connect with Boyce on LinkedIn.