Annuities: A fee study

One last thing, and then I’ll leave fees alone, at least for a little while.

The other day one of my friends asked me for some advice on a product her financial advisor sold her – a variable annuity.  She had heard a lot of bad press about the products. But her advisor said that his annuity was different from the others. She still wasn’t convinced, so she came to me for a second opinion.

 What are Variable Annuities?

Variable annuities are insurance contracts under which the buyer makes a lump sum or series of payments in exchange for future payments, sometimes lasting for life (somewhat like a pension).  You get a tax deferral on earnings. And the contracts usually have a death benefit, if you die with the annuity still in place. It’s like a hybrid of a life insurance policy and a retirement account.

I hate them

In short, I hate annuities…with a passion more than most. Many advisors do, especially those with a fiduciary responsibility to their clients (e.g., CFP®). I hate them for multiple reasons.

Most importantly, they are expensive. In addition to higher expense ratios for investments within an annuity, the fees for annuities usually consist of a sales fee (anywhere from 3 – 6% of the money invested), a mortality and expenses fee (.5-1.5%), a contract fee (a flat charge if you have below a minimum threshold invested), and fees for withdrawing your money early (a sliding scale sometimes starting as high as 10%). I’ve seen enough “fees” in just that sentence to keep me away from annuities for life.

Taking into account all of the costs, annuities don’t fit my investing approach. While it’s possible to own broad market index funds within the annuity, you pay five to six times more than you would if you had purchased the index in another investment vehicle. And when I pointed out these fees to my friend, she knew her advisor’s annuity was just like the others: expensive.

As if I needed another reason to hate annuities

The more personal reason of why I hate annuities involves my mom and a “financial advisor,” who took advantage of her when my dad died.  My dad had left my mom a considerable amount of money from his retirement accounts. After rolling over the money into an IRA, the advisor proceeded to put her money in the annuity within the retirement account (the ultimate no no), and pocket $40,000 of her money in the process.

In the subsequent years, when my mom needed money to move to another state, buy a car, or meet her living expense, she incurred substantial surrender charges for withdrawing her funds. She ended up losing a lot of her investment because she trusted this advisor and did not understand the fees for the product.

I hope this week has opened your eyes to the types of costs associated with your investments and how these costs can decimate your return.  I also hope you have developed a keen awareness of what to look for in your investments. My goal is to prevent others from experiencing the situations that my friend and my mom – both extremely smart, accomplished women – found themselves in.