We have two main types of annuities. One is called a fixed annuity, and one is a variable annuity.
A fixed means your rate is fixed, usually once a year or once every few years. They invest typically in bonds. A typical fixed annuity is going to be paying around 3% right now. A
A variable annuity works like a 401(k). In other words, you have investment options or mutual funds within the plan. You choose the funds you want to invest in; and whatever those funds earn, that’s what you earn.
We’re starting to hear a lot of these annuities popping back up, because they’re putting these riders (extra things, extra layers) on these insurance-type products. These extra things can cost you a lot more money.
The reason people are enticed, of course… Well, if you go down to your bank and you’re looking for CDs, the rates are very low. If you can get 1% on a CD, you think you’re doing well right now. So, when you start to hear of any product offering a little bit more you start chasing that yield.
But they have very high annual costs. Your basic annuity is going to be 1.8% to 2% just for the basic annuity. That’s to start you off. Then, you’re going to have extra things that come on top of that. They also have limited investment choices, and so if you use a variable annuity, you have to use their choices. Then, the big problem with annuities are surrender charges. It makes them very inflexible. You can’t get to your money. Typical surrender charges run six to nine years with very hefty penalties. So if you have something that happens (and of course with six to nine years, anything could happen) and you need that money, that could be a real problem when you try to take it out in lump sums and you suffer that penalty.
As far as riders are concerned, I say it’s like an extra thing. It’s like going through the line at Piccadilly, and you get the basic entrée with two vegetables; but if you want dessert, it’s extra. And your tea is extra. That’s the way these riders work. You start with a basic annuity (1.8%). There’s one that’s become very popular. It’s guaranteed interest. Typical is around 5%, but people think that’s guaranteed basically on the balance. It’s really guaranteed as to your monthly income sometime in the future. The average cost of that guarantee is 1%. So you’re getting a guarantee of 5%, but you’re paying 1% for it. Figure that one out. You can also have guaranteed death benefits. Because these are insurance products, they like to stick that one in. The cost of that is about an extra 1%. So if you get those two, plus your typical annuity, now you’re paying almost 4% for this product when you can find things out there doing the same thing.
And I would say: Don’t be enticed by that guarantee. They’re all kinds of little stipulations to it, and you can get caught. Be very cautious. Read the fine print. We find that most people really don’t fit the profile for an annuity. If you do want to put some money in, don’t put everything in there. Limit how much you put in there, because it is very inflexible.
One more thing: There’s a great Money Magazine article in the January/February Money Magazine, and it talks about these annuities. It’s called “No Pot of Gold.” I would encourage you to read that before you sign on the dotted line.
("Variable Annuities - No Pot of Gold" by Lisa Gibbs)