When you’re ready to head down the path to retirement, you have to figure out the best way to organize your retirement savings so that you don’t run out of money. Studies have confirmed that people who receive a regular pension income during retirement are happier than people who don’t have a pension income. Furthermore, it’s less stressful to spend money from an account earmarked as income as opposed to investment accounts that are exposed to market loss and risk.
You might be drawn to the appeal of annuities because of their ability to give you a guaranteed cash flow during retirement, but there are a number of risks to be aware of before you buy. We’ve put together a list of the top 5 things your broker might not warn you about so that you can enter retirement better prepared.
Risk #1: High Fees
While it’s true that an annuity is the only type of investment vehicle that can turn your savings into a reliable income stream, it’s also true that not all annuities are created equal. Some of them have high fees that don’t necessarily translate to better benefits for you.
It can be difficult to figure out if you’re paying too much in fees for the annuity you want. Here are some simple pointers:
Fees that are Standard: A surrender charge is common for most annuities because these are long-term investments.
Fees to avoid: The variable annuity is the only type of annuity that charges an M&E risk fee. This fee is typically a 1 percent charge that directly reduces the earning power of your investment.
BEWARE: variable annuities that advertise no surrender charges. They often charge much higher fees in other areas to make up for this supposed benefit.
Risk #2 Brokerage Commissions
A commission is a fee charged by a broker or financial professional in exchange for providing investment advice or for handling the purchase or sale of a security. What’s tricky about this is that not all annuities are securities. The variable annuity is the only type of annuity considered a security product by the SEC and as such it typically pays financial professionals a larger commission than other types of annuities.
Commissions that are Standard: It’s typical for all annuities to pay out a commission to the agent who sells the annuity, and these are typically issued by the life insurance company. Unlike front-load brokerage fees for securities, if you invest $500,000 in an annuity, you will see $500,000 in your account.
Commissions to avoid: As much as possible, you want to avoid ongoing commission fees, particularly for services that you don’t even need. One common example of this is the income rider on a variable annuity that sometimes masquerades as a guaranteed rate of return. If you think you might have bought a variable annuity and have concerns, GO HERE.
BEWARE: There are two kinds of commissions: one-time charges, and those that reoccur. Lately, we’ve seen variable annuities that charge the investor a recurring commission fee every time the investor contributes money to their retirement plan. These are common with annuities sold to teachers inside of 403(b) plans. If you think you might have this type of annuity, reach out to one of our advisors to have your annuity tested.
Risk#3: Losing the Money
If you die before you have the opportunity to spend the money in your retirement account, the money typically goes to your named beneficiary, and they will inherit this money. If you die before you spend all of the money in your annuity, however, your family may not get the rest of the money.
Benefits that will take care of your family: If you are concerned about income planning for your spouse, then you will want to elect some type of joint-life option. This can be done for a fee using an income rider, or you might elect to receive a slightly lower monthly payment with joint-life and survivor options.
Benefits to avoid: One benefit offered by the variable annuity is a death benefit. This benefit promises that if your account takes a catastrophic hit during the same year you happen to die, your family will get at least the total contributions put into the annuity. Given the high expenses and fees of the variable annuity, investors should consider very carefully the odds of catastrophic market loss occurring during the same year as the death of the annuitant.
BEWARE: It’s common for immediate annuities to offer higher monthly income amounts, but they may not pay out to your beneficiaries in the event of your death. To have the terms of your immediate annuity analyzed by a professional, fill out our simple form.
Risk#4: Redundant Benefits
Annuities are sometimes sold as a way to grow your retirement savings tax-deferred, which means the money grows faster because you don’t have to pay taxes on the gains. However, if you are putting an annuity inside a retirement account such as a 403(b), or if you are rolling the money in your 401(k) or IRA into an annuity, then you are already getting tax deferral.
Standard Tax-deferred growth: All retirement accounts such as 401(k)s and IRA offer investors a tax-deferred growth of their money. All annuities may also grow tax-deferred.
Taxes to avoid: If you are rolling an IRA or 401(k) into an annuity, you should be able to roll over the money into an annuity without having to pay a distribution tax.
BEWARE: If you are not yet age 59 ½, then the IRS may charge you a 10 percent tax penalty for accessing the money in your retirement account too soon. You may be able to avoid this tax by transferring your IRA or 401(k) into an immediate annuity that pays out over the course of your life or the life of your spouse, sometimes called a life contingent payment option. If you have questions about how to roll over your retirement money into an annuity, GO HERE.
Risk #5: Buying the Annuity Too Soon
Annuities are designed to either give you income now or at a later date. Annuities that pay you the income later are known as deferred annuities. One very common type of deferred annuity sold to investors today is the variable annuity.
The variable annuity is unique among all annuities for several reasons, namely that it invests directly in the stock market. For this reason, it is a more complicated investment vehicle that charges higher fees; it also typically pays out higher commissions to brokers.
The way a variable annuity promises a guaranteed stream of income to investors may have you paying additional fee years before you need to access the income. While this is common with income riders in order to give investor’s flexibility, the variable annuity also charges the M&E risk fee we mentioned earlier.
These two fees combined typically add a 2 percent ongoing fee that is charged over the life of the annuity, year after year, whether you are drawing the income or not. For this reason, it might be prudent to look at your retirement timeline when assessing whether or not you really need the other benefits offered by the variable annuity.
Buying an annuity with your retirement savings can be a great way to secure a lifetime stream of income that you can feel secure about, but it’s worth taking the time to make sure you get the right annuity. Thank you for visiting our site. If you have any questions about the risks of buying an annuity, please feel free to reach out to one of our advisors today. Our mission is to help educate investors so that you can enjoy a happier, healthier retirement.