Annuities – Be Sure You Know What You Are Getting

November 12, 2014  |  

Annuities – Be Sure You Know What You Are Getting

AnnuitiesKey Takeaways

  • An annuity is an insurance product that can pay out income. It’s a popular option for investors seeking a steady stream of income in retirement.
  • Annuities can be a valuable tool if you are in a high tax bracket, have exhausted your pre-tax savings opportunities (like a 401(k)), and have a long-term time horizon. Just beware of the costs.
  • Annuities generally fall into one of three categories: (a) fixed; (b) immediate and (c) variable.

If you own, or are considering purchasing an annuity, make sure you have the product evaluated by an independent party.  Although we do not sell annuities or insurance at Independence Advisors, LLC, we have decades of experience in evaluating them.  Our firm recently performed an analysis for a client who had substantial investment in three annuity products. As a result of the analysis, we were able to recommend a more appropriate solution for our client. This action enabled him to maintain the tax-deferral benefit built into the annuities while reducing his expenses by more than $148,000 per year!

Generally speaking, annuities fall into three major categories:

  1. Fixed annuities which pay a specific interest rate for a defined period, not unlike a bank CD.
  2. Immediate annuities which are (as the name implies) a way of turning a lump-sum of cash into an immediate stream of payments.
  3. Variable annuities which are typically pursued to generate tax-deferred savings, a death benefit or the ability to receive periodic payments.

If it sounds too good to be true….

With annuities, the key is to determine if the product and time horizon are really right for you, not to mention the costs.

As the old saying goes: “If it sounds too good to be true, then it probably is.” In my experience, this is often the case with annuity products. Annuities in and of themselves can be a valuable tool under the right circumstance. Unfortunately, they are too often “sold” to individuals who might be better off avoiding them entirely.

Typically, annuities are pitched as the perfect solution for your retirement woes. They come with fancy bells and whistles intended to bring you income “guarantees” and other benefits. They have exotic names such as “Guaranteed Minimum Income Benefit” (GMIB), “Stepped up Death Benefit” and “Guaranteed Minimum Withdrawal Benefit” (GMWB), to name a few. The problem with these bells and whistles is that each comes with additional costs and restrictions. Additionally, these “guarantees” are only as solid as the insurance company providing them to you.

Seek suitability

Back in 1999, when I worked in Vanguard’s variable annuity marketing department, I spent much of my day on the telephone discussing the suitability of annuity products with potential clients.  Vanguard’s “no-load” (no commission) structure allowed me to speak objectively to clients with no conflict of interest.  Most often, annuities were not an appropriate choice for the person on the other end of the line.  Unfortunately, they were typically doing research after the fact, having already been sold a product that wasn’t right for them. This was back in the day when agents and brokers were earning whopping up-front commissions of 6 to 9 percent on the full amount of the investment.

You might wonder how an insurance company could pay a broker $45,000 for the sale of just one $500,000 variable annuity. The answer is that the company knew it would recoup the hefty commission (and then some) through the underlying costs they charged clients. That’s also why variable annuities often have steep “surrender penalties” for a period of years following the purchase.

As I stated earlier, an annuity can be a valuable tool under just the right circumstance. For example, if you are in a high tax bracket, and have exhausted all of your pre-tax savings opportunities (like a 401(k)), have at least a 10-year time horizon on the investment, and don’t mind that any non-spouse heirs will be taxed upon payout. In those cases, a variable annuity could be the right choice for you.

However, it is very important to know what you are purchasing. This link to the U.S. Securities and Exchange Commission (SEC) site does a great job of outlining what to keep in mind when considering an annuity purchase.


At Independence Advisors, LLC, we do not sell annuities or insurance products. But we do provide our clients with access to no-load, low-cost annuity products from TIAA-CREF and Vanguard, among others, when appropriate.

If you’d like to learn more about the pros and cons of annuities, please contact me for a complimentary analysis of your policies. (610) 695-8070

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES
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