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Annuity Incongruity Equals Ambiguity in Perpetuity?

If you happen to own an annuity, you can save yourself five minutes and stop reading. It's too late. They've gotcha. If you don't own an annuity, you're gonna want to read every word. I hope to save at least a few souls from the investment Hell that annuities can represent.
 
So, what exactly is an annuity? It's basically a promise, usually by an insurance company, to pay you a certain amount per year for a certain period of time, often for your lifetime. In exchange for this promise, you fork over a chunk of change to the insurance company. Sounds simple right?

Much like the title to this piece, you'd be mistaken to think the world of annuities is simple. Or easy. I've never bought or sold an annuity, so I'm a biased non-expert with these instruments. But my thirty-plus years of investment experience still doesn't make for a fair fight when trying to understand these often opaque, fee-laden instruments devised by professional actuaries who are better armed than most of us at assessing the odds of the payout.
 
Annuity providers have gotten very creative with the terms and provisions of annuities. And then there's the matter of commissions. Incentives are a big driver of behavior, and since annuity sellers often pay large upfront commissions, the salespeople--annuities are sold, not bought--who sell this stuff, tend to push it hard and sell a lot. Most of these things should have a big fat label attached: BUYER BEWARE.
 
There are two main annuity types. You fork over a big chunk of cash and the insurance company starts making payments to you. Congratulations, you bought an immediate annuity. Or, you make an upfront or series of payments but agree to receive your payout in the future. You own a deferred annuity.
 
For added confusion, your annuity can be fixed or variable. A fixed annuity as the name implies means when the time comes for your payout, the insurance company pays you a fixed rate. A variable annuity bases the payout on the performance of the underlying investments, often the stock market. The variable terms are usually incomprehensible even for intelligent, informed investors. Annuity novices have no chance at understanding.
 
Once you're ensconced in one of these very long-term commitments, you will be hard-pressed to exit the contract. Why? Surrender charges. They're usually so punitive that withdrawing your funds won't make economic sense. And that's what the annuity provider wants to happen. Why? Because the insurance company needs the recoup the fat commission it paid out to the salesperson who sold you the annuity in the first place. Additionally, the insurance company can continue to collect fees from managing your annuity for decades. Who says it's not a sweet deal? It is. For the insurer. And the salesperson. Not so much for you.
 
Ultimately, what the average annuity buyer gets is a high-cost, illiquid investment with often complex terms and conditions, penalties for early withdrawal, and some negative tax aspects. In exchange for the bad stuff, you get a guarantee of a yearly income stream. You'll have to determine if the tradeoffs are worth it. I'm pretty sure the person selling you the annuity isn't going to offer objective advice, not with thousands of dollars of commissions riding on your decision. As the Latin phrase says: "Caveat Emptor." Which means let the buyer beware. You shouldn't need to adopt this stance, but some corners of the financial world are akin to being in a Roman Coliseum fighting alone.
 
Now, does my article title make any sense? If not, just think of it as an annuity.



-John Heldman, CFA


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