Be Careful of Annuities

I met a respected friend over the holiday who is testing out selling Annuities. He seemed quite gung ho about this new opportunity, so I kept my beliefs about the product to myself. The part that made me cringe was when he talked about how easy it was because of the turbulent market.

It is this kind of thinking that allows people to take advantage of people's fears...predominantly older people. So if you have some money to invest, or have someone that's trying to talk to you about moving money into an Annuity, let's quickly explore some "gray areas" that may not be given much detail during the selling pitch. I used to be a stock broker, and while I didn't sell Annuities, I was licensed to sell them if I wanted.

First and foremost, an Annuity is an Insurance Product. It is not a wealth building tool, but something people use because they are scared of losing the value of their money/investments. If you have no stomach for the market, and let's face it...who does these days, then perhaps an Insurance policy protecting your money(which is what an Annuity is) is for you. I could have made an argument(will explain past tense later) that you could do just as well with a conservative investment elsewhere, but an Annuity does accomplish the preservation of money.

Secondly, the avoidance of probate. Seemingly one of the big pitches is that an Annuity avoids probate when you die. There are two things misleading about this. Firstly, I believe that some allow the people who are buying the Annuity to believe that probate is the taxes that are charged to the estate after death, aka the death tax. This is misleading, probate is not the avoidance of the death tax. Uncle Sam will get his money, regardless of your belief about taxing money that has already been taxed once.

What probate is, is the state appointing someone to oversee a deceased persons estate in the event that no one has been selected to do this by the deceased. The state winds up charging a fee for this service, sometimes up to 5% of the estate...then you get taxed.

So the other thing is that I think salesmen are leading people to think that an Annuity is the only unique product that avoids probate. This is, of course, untrue. Aside from setting up a Trust, any IRA and even some brokerage accounts with a Designated Beneficiary avoid probate. Because all probate does is divvy up assets, so if you have a beneficiary, there are no assets to divvy up. Of course, taxes are still due on the estate.

Another main thing that salesmen try to do is brush over the fees of the Annuity and the other terms that could be unflattering, such as a termination fee, should you want to cash out or need access to the bulk of your assets early.

It's these fees that are the main reason I don't like Annuities. Because some annuities sell you on the fact that your annuity is invested in the market and you can actually grow the value of your annuity, the large fees are overlooked or underrepresented. If you want to invest in the market, get a brokerage account and pay little to no fees. The fees you pay are, again, for the security of being in an Insurance product. It's like you're paying a premium as you would for your car or home, only it is coming out of your nest egg. You may as well find a good bank and put your money into the money market fund there and not pay premiums.

Now, to even more worrisome thoughts. The reason I stated earlier that I would have made the argument that you would have had just as safe an investment as an Annuity, was because of US Treasuries and Mortgage Backed Securities. Of course the Mortgate Backed Securities are in the toilet, and there are worries with the exponentially increasing debt that the US Government is taking on, that US Treasuries may not be as safe an investment as they once were....they may even be at risk of losing their AAA Credit rating. Yes, it is conceivable that the US Government could lose it's credit rating.

And finally...what if insurance companies continue to fail like AIG? Will the Government guarantee all those annuities? Well, insurance companies aren't FDIC insured, so they aren't obligated to.

Let's simply look at the Annuities from the Insurance Company perspective. You sell people market insurance, with the hope of investing in the market yourself and then just keeping the profits you make in the market. But if the market continues to be in the crapper, how do you make money on Annuities if your an Insurance Company? You continue to increase fees until the market suffocates you and your Annuities are worth less and less. Neither of those options bode well for the annuity holder.

So while I'm no longer an investment consultant and won't recommend that you don't buy an annuity. I do recommend that you do all your homework before getting into an Insurance Product that's sold as a complicated investment vehicle.