The title of this post is a phrase I’d like add to the urban dictionary. The definition would be similar to “buyer beware” or “proceed with caution.”
As a licensed Insurance Consultant, I often review a client’s or prospective client’s annuities and insurance products. These are best reviewed through the lens of the client’s overall financial plan, and while they can be situationally appropriate, they do add a layer of complexity that should be evaluated.
An annuity is a tax-deferred insurance-based product, a contract between the owner and insurance company. The contract will have varying terms and conditions detailed in a prospectus or sales material, depending on the type of product. There are too many types products to discuss here, but over the years these are the questions that most often come up surrounding annuities:
- What is the cost of the underlying guarantee? Ultimately there are higher expenses with insurance-based products compared to investments such as stocks and bonds because you are transferring a risk to the insurance company. For example, annuities transfer the risk of outliving your savings, and life insurance transfers the risk of a short life or lack of savings. Common terms that define the cost include mortality & expense (M&E), administrative charge, spread, & caps. We’ve seen high underlying fund expenses on top of the insurance expenses and all these fees can really impact returns over time.
- What is a Living Benefit? These are riders that add features to the contract and may require action from the owner to receive the promised value. Some common riders include Guaranteed Accumulation Benefit, Guaranteed Withdrawal Benefit, and Guaranteed Income Benefit. Important to note, each rider adds to the cost of the contract.
- Are there features of this product that require action to receive the guarantee? Annuities require you to take action to receive the promised guarantee. This could be the election of a rider payout or annuitization. With annuitization, you would receive a guaranteed series of payments based on your life expectancy, or if a joint and survivor option is selected, both you and your spouse would receive payments. In our experience, most annuity owners don’t actually annuitize their contracts, even though this is where the guarantee from the insurance company exists.
- Should I keep this product? The answer is it depends. We prefer to review a client’s financial plan before giving a definitive answer. Again, there are certain situations where an annuity might be appropriate, but there’s also a reason for the saying “annuities are sold, not bought.” By reviewing the costs, surrender period, and penalties, we can give you a good idea if a product is beneficial or detrimental to you and your specific situation.
- Does the death benefit of the annuity get a step-up in basis? No, is the simple answer. Unlike a portfolio of stocks and bonds that will receive a step-up in cost basis at the time of the owner’s death, gains within a non-qualified annuity contract are treated as ordinary income subject to beneficiary settlement options. This lack of a step-up is one of the pitfalls of owning an annuity.
The above list of questions isn’t meant to be all encompassing, just some of the more common discussion topics that seem to occur. We’re happy to help our clients discuss their personal situation and analyze annuities they have or are being pitched.
Clicking on the links above may result in you leaving the Pittenger & Anderson, Inc. website. The opinions and ideas expressed on these external websites are those of third-party vendors and Pittenger & Anderson, Inc. has not approved or endorsed any of this third-party content. For the full Terms & Conditions of using the Pittenger & Anderson, Inc. website, click on this link.
Pittenger & Anderson, Inc. does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Additionally, the information presented here is not intended to be a recommendation to buy or sell any specific security. To learn more about our firm and investment approach, check out our Form ADV.
