Ken Roberts


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August 29, 2013
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Market Beat: Understanding annuities

Annuities are part of the retirement plans of many Americans. Most people really don’t understand how annuities work and some investors have been taken advantage of by unscrupulous annuity sales practices.

An annuity is a contract between an investor and an insurance company. There are two types of annuities — fixed and variable.

A fixed annuity gives the investor a fixed, guaranteed rate of return, while the variable annuity has a variety of mutual fund sub-accounts to choose from, which gives the investor the opportunity to invest as it suits him or her and the potential for market-type returns.

Essentially, annuities have three features which could be advantageous to the right person at the right time.

One, annuities provide for tax deferral, the funds within an annuity contract grow without taxation until they are distributed.

Two, annuities have a guaranteed death benefit from the issuing insurance company.

Three, if you decide to annuitize your contract, an annuity can provide a guaranteed income stream for a certain period or your entire life.

While those features may sound attractive and may be worthwhile to some people, they also come with a cost. Annuities can have very high expense ratios and may have surrender charges.

Surrender charges can be as high as 7 percent in the first year and typically decline to zero over a period of seven years or so. The mortality and expense charges are normally about 1.25 percent per year. Administrative fees are usually about 0.15 percent annually.

The underlying investment funds also have an expense ratio which varies, but can be about 1 percent. Additional features like stepped up death benefits and guaranteed income riders will also have a cost.

If you’re considering purchasing an annuity look very closely at all of the expenses, the costs can easily add up to 3 percent or more per year and can be a real drag on investment performance over time.

Investors should also be careful if they are thinking about placing retirement funds from a qualified retirement plan like a 401k into an annuity because those funds already have a tax deferred status.

It may not make sense to pay the extra expense for an annuity with funds that are already tax deferred.

If an annuity does seem to be beneficial due to the tax deferral, death benefit or guaranteed income, you should probably consider a no load annuity with low expenses and no surrender charge.

If you own an existing contract and have had it for a long time, it may be worth evaluating it to see if you can lower the expenses.

Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.


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Tahoe Daily Tribune Updated Aug 29, 2013 04:19PM Published Aug 29, 2013 01:16PM Copyright 2013 Tahoe Daily Tribune. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.