One major reason why people fear investing is that financial institutions have created so many different types of investment products that it is nearly impossible to choose among them. This is somewhat just the nature of a market economy, whereby every possible “flavor” of a product is offered for sale by companies to consumers. Unfortunately, it also is partly a bit of malevolence on the part of financial companies, since offering a mind-numbing range of highly complicated products allows their salespeople to more easily steer customers toward the products that are most profitable for them and their company.
Nowhere is this more clearly the case than with insurance companies and their most heavily marketed product, called an “annuity.”
If you don’t know what an annuity is, don’t feel bad. It’s not the sort of thing people have any usual reason to think about (that is, until your “helpful” life insurance agent darkens your door and insists you have to have one).
An annuity in its simplest form is just a sum of money paid at regular intervals, such as monthly or yearly. An example is a normal company pension, which your employer pays to you on a monthly basis after you retire and until you pass away. In fact, the original idea behind the creation of the annuity investment product was to provide a regular and guaranteed stream of income in retirement for people who desired it. You make payments to the insurance company over several years, and upon retirement, they make a contractually determined stream of payments to you until you die. A pretty good concept, right?
Not in the hands of insurance companies!
These companies have made annuity investing so complicated that you would need a team of financial planners, attorneys, and tax accountants to figure out what the hell you’re buying. Here are the questions your annuity salesperson is likely to ask you: Do you want your annuity payments to them to be “single” or “flexible?” Do you want your money invested as “fixed,” “variable,” or “equity-indexed?” Do you want their payments back to you to be “immediate” or “deferred?” And what “special features” would you like to add to your annuity: “inflation protection,” “living benefits,” “ratcheting,” “bonusing,” etc.?
So what is it, along with ridiculous and unnecessary complexity, that makes annuities an investment product you must avoid? Let me count the ways…
- Sky-high fees. The complicated nature of most annuity products both causes, and makes it easy for insurance companies to obscure, several layers of fees and expenses. Annuities are subject to fees such as salespeople’s commissions, administrative charges, mutual fund expenses at each “sublevel” of investment, so-called “M&E” (mortality and expense fees), and charges for special features and other contract “riders.” Most of these expenses are charged annually, meaning you pay for them each and every year you own the investment.
- Weak investment performance. Since state regulators require that insurance companies’ assets be invested conservatively, annuities earn poor investment returns, notwithstanding the insurance company salesperson’s enthusiastic claims of the untold wealth their annuity will build for you.
- Lack of transparency. Once again due to the complicated structure of most annuities, you won’t be able to track with any measure of specificity or accuracy what your investment is earning or what total fees you are paying. It will be a “black box,” whereupon money goes in and eventually comes back out, but its true performance as an investment will be forever a mystery.
- Lack of promised tax benefits. One possible advantage of certain types of annuities is tax advantages, but these can be easily lost if the annuity product you are sold is not structured properly for your personal tax situation. Many insurance salespeople are not careful about this.
- Costly termination fees. Insurance companies aren’t stupid—they want to keep you in their highly profitable (for them) annuity, so they charge termination fees of 10% or more if you choose to bail on your annuity after the fact.
Insurance companies literally spend a fortune marketing annuities to the public. And their salespeople are adamant that you must purchase one if you want to secure your family’s future. If you don’t, you are a poor provider, or worse, a louse and a miserable excuse for an adult and parent.
As a general lesson for you: the harder an industry or company markets something to you, usually (always?), the better it is for them and the worse it is for you. Why do you think car companies, electronics makers, etc. all market extended warranties so adamantly? Because they will greatly benefit you and save you a lot of money? Uh, no.
So when it comes to annuities, buyer beware—or, better yet, just tell your friendly insurance agent that you’ve pissed enough money down a hole this month, so he/she’s too late!