Question: I have a qualified annuity (inside an IRA) with a company that was issued in 1997. I called them to see if I can borrow against the principal, but they said no. I thought that there was a way to borrow from an annuity. Do I have to just surrender the funds and pay the penalties and taxes?
Answer:
- Short Answer: The answer is no because IRAs do not allow loans.
- We are beginning to see annuities offer this feature as one of many being put forward for customers and advisors to consider.
- Our position is that we will have to wait and see if these features have any validity.
- Gut tells us that they are just another hook to be able to add more fees.
Question: I bought an annuity a few years ago, but I don’t want it anymore. Is there a way to get rid of it?
Answer:
- You can cancel your annuity at any time.
- You may have to pay an early cancellation fee known as a surrender charge.
- Federal government will also penalize you if you cancel your annuity before you reach age 59½.
- Your annuity contract should have its surrender charges explained in the contract itself.
- If you cancel before the date stipulated, you will be charged a fee that is a percentage of the withdrawn amount.
- The surrender charge is usually reduced as the annuity gets older and typically ends after the first 10 years.
- The federal government may penalize you 10% of the earnings portion of the withdrawn amount if you cancel your annuity before you reach age 59½.
- The government will charge the same percentage on any amount you withdraw from your annuitybefore age 59½, to the extent the withdrawal represents untaxed earnings, even if you do not cancel the contract.
- Before you cancel your annuity, speak to a trusted financial adviser to make sure you understand any surrender charges or governmental penalties you may incur.
Question: Where do you see the appropriate use of annuities?
Answer:
- We think it is important for our clients to understand our philosophy regarding annuities
- We believe that certain annuities have a strategic place in someone’s portfolio, but
- They should primarily be viewed as a “risk transfer” tool.
- Most of what we see going on in today’s market, regardless of the type of annuity, is that it is being positioned as a “single solution” that can solve all financial issues a client could want.
- We have found that clients who have bought an annuity as a single solution end up being very frustrated.
Question: Why do you say that annuities should only be considered on the “fixed income” side of the investment spectrum?
Answer:
- Going back to our philosophy and the inherent features of why anyone would consider an annuity:
- The guaranteed income for life feature allows clients that want to limit the cost of a guaranteed income for life to be able to do so, and
- Offsets the risk that the income recipient outlives the resource, i.e., divorcees, clients with dwindling assets that want to make sure that they do not outlive their income, etc.
- As for accumulating annuity versions, we focus on types that offer guarantees of principal:
- Fixed Guaranteed offer a rate and term, much like CDs, but the big difference is that growth, while it is an annuity, will be tax deferred.
- Fixed Indexed annuities offer the prospect of a higher return but still should only be considered against other fixed income instruments.
- The index, most typically the S&P 500, is only referenced as a measuring stick to determine what will be credited to a client’s annuity account.
- Most important to understand that the index is a benchmark and doesn’t include dividends.
- Historically we have found that they are structured to be able to return to the client approximately 60%-70% of the movement of the S&P over whatever period we are trying to measure.
- By far the biggest problem we see is that advisers or potential clients believe that the annuity being presented to them will solve all of their problems:
- Particularly, Variable Annuities, as clients believe the annuity will offer them “market growth” plus all of the protection offered through the guaranteed income riders, guaranteed death benefits, bonuses, etc.
- The problem that we are seeing is that to be able to offer all of the Fixed Income features, a variable annuity’s annual cost on average can be more than 4%.
- We have never seen where a portfolio invested and growing in anything can “outperform” with a 4% load to overcome in good markets and bad.
- As a result, the client is then rendered to the rider features, which we have found to be subpar when we compare them to other options in the marketplace.
Question: We hear more and more about all of the attractive features of annuities, 6% or 8% guarantees, what is going on in that market?
Answer:
- Today there is a lot of confusion about what actually is going on inside an annuity, particularly variable annuities.
- Specifically, any annuity that offers a guaranteed rate like that is doing so via an optional rider.
- The rider defines the growth at 6% or 8% as well as the rate of distribution, when and if a client elects to take distributions.
- Experience tells me that most people get enamored with the growth rate and have no idea that it locks them into a subpar rate of distribution when compared to other income generating annuities.
- Most important to understand is that value is a “fictional” number generated and reflected on statements by the insurance company, and it is only accessible as an income stream, not available if they surrender the contract.
- Also, there can be a significant cost to add this rider which increases the hurdle rate for any growth to occur in their actual account, etc.
Question: Another topic we hear about is that some companies are promoting up front bonuses of as much as 10%, how does that work?
Answer:
- You can bet that whatever is being given to you on the front end is either not fully yours until the surrender period is up, or by taking the upfront bonus, you are subjecting your balance to subpar performance.
- In all indexed annuity marketing material that I’ve seen, it discloses that if a client takes an upfront bonus, the future crediting rates will be less competitive than if the client does not accept the upfront bonus.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
