Friday, July 15, 2011

Annuity is a bad investment - says Suze Orman




By great financial Plan

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“An annuity is just a bad investment.” You’ve probably heard Suze Orman, your uncle, or maybe others say something like that. But do you really know why they think that? Maybe not. The truth is, an annuity is just another investment tool for personal financial planning. It’s another tool in the bag right next to the mutual funds, stocks, bonds, options, and everything else. It may not be the right investment for you, but then again it may be.
Like everything else in life, there are good ones and bad ones. And there are certainly plenty of annuities out there that we would tell you to avoid like the plague. But we don’t think it’s fair to say that all annuities are bad. In fact, some are very good for certain situations.
So lets review the different types of annuities out there and discuss which ones may the best for you to consider for your portfolio.
First, annuities are contracts between you and the life insurance company that issued it. They are guaranteed by the insurance company, so the financial soundness of the company is a very important thing to consider.
Annuities can all be placed in two basic categories: Fixed or Variable. All types can be used in personal financial planning. They will also be differentiated by whether they pay you income, or grow (deferred income). A fixed annuity is one designed to pay a fixed rate of interest, or make a series of guaranteed fixed payments to the owner. A variable, annuity is a contract designed to either make variable income payments to the owner, or to grow at a variable rate of return (based on a variety of factors which we will cover later). OK, so here we go.

Fixed Income Annuities These are the traditional types of contracts that most people think of when they hear the word annuity. These work like a pension in that they pay the owner a fixed income stream for a certain period of time. This could be for a certain period of years, or for a lifetime. These are a great way to provide a guaranteed income stream that will never change or go away (which most people find very attractive). A lifetime payout could be based on the life expectancy of one owner or more than one owner. The more lives used in the calculation, the less the payment is going to be each month. This is because life expectancy of multiple people is always longer than the life expectancy of one person.

Fixed Deferred Annuities This is a type of annuity that works like a bank CD. They do not pay the owner monthly income. Instead, they earn a fixed rate of interest and are designed to grow. They also have a maturity date that can range from 3 – 10 years. One advantage that they have over CDs is that the earning each year are tax-deferred. This means that you will eventually pay the taxes on the earnings, but not until you take the money out of the account. This tax-deferred status makes them a very attractive choice for people in higher tax brackets.

Variable Income Annuities These are designed to pay an income stream to the owner, usually for life. But instead of being a fixed, guaranteed income stream, these payments will fluctuate based on certain market conditions. Usually the money invested in them is allocated by the owner to investment sub-accounts (like mutual funds). If the value of the sub-accounts goes up, the monthly payments go up. If the value goes down, the monthly payments go down. This can be a good piece of a financial plan for a long term inflation hedge, but you would never want to base very much of your retirement income on market fluctuations. As we have seen in this last year, the market lost over 50% of its value. That means your income from this annuity would have declined by that same amount.

Variable Deferred Annuities These vehicles are designed to grow, not pay income. And again, the money is invested into sub-accounts similar to mutual funds. You as the owner get to allocate your money as you wish, and you can usually make changes whenever you want to. Once again, these annuities are tax-deferred. This means that when you make a change to your investment allocation, you don’t have to pay any taxes on the realized capital gains. This again is a nice advantage over investing through taxable accounts. These contracts also usually have a “death benefit” associated with them. It’s not really like life insurance, but similar. The death benefit here means that if you die, your beneficiaries are guaranteed to get back at least what you put into it. So if you put $100,000 into a variable deferred annuity, and the market dropped, and then you died, your beneficiaries would get $100,000. That’s a nice feature. But it comes with a price.
All variable annuities, both income and deferred, have some extra built in costs. In addition to the internal management expenses of the sub-accounts, annuities have some extra fees called “mortality and expense” or “M&E” charges. These typically are about 1.25% to 1.5% per year.

Now there is a hybrid type of annuity called an Equity Indexed Annuity. These are another deferred contract, and it combines some of the benefits of the fixed, guaranteed annuities with the growth potential of the variable ones. These vehicles are designed to pay a minimum fixed rate of interest each year, plus additional interest in years when the stock market is positive. In years when the stock market is down, the principal is guaranteed (it will not go down). When the market is up, the annuity will pay interest based on a formula that captures part of the market performance (not all of it). Owners are able to choose between various interest crediting methods where the interest is linked to the performance of different market indexes.
For example, one crediting method is called annual point-to-point. Let’s say the index being used is the S&P500. The contract will pay interest equal to the performance of the S&P500 but it will be capped out at a certain percentage, let’s say 7.25%. So if the S&P500 goes up 7.25% in that year, you would earn 7.25%. But if the market goes up 12%, you still only earn 7.25%.
Another crediting method is the monthly point-to-point. With this method you get interest equal to whatever the index did in that month, with a cap, lets say 2.5%. So if the market goes up 1% in a month, that’s what you earn for that month. If the market goes up 2.5%, you earn 2.5% for that month. If it goes up 4%, you only earn 2.5%. If the market drops off a cliff in a given month, it can wipe out earnings from previous months in that year, but your contract won’t ever go negative in a given year.
Each year (with most contracts) the game resets. This means that you don’t have to wait for the market to get back up to where it was when you first bought the contract in order to make money. So lets say you bought the contract when the S&P500 was at 900, and a year later on the contract anniversary the S&P500 is at 750. You would not have lost any money in that year. And now lets say that in year 2, the market goes up 7%, you would earn 7% (as long as that’s less than your annual cap).
Also, each year your earnings are locked in, and the contract cannot fall below that new value. This is also very nice in these volatile markets.

As a summary, there are good annuities and there are bad ones. You just need to be careful, as with any investment products. Just like there are good mutual funds and there are bad mutual funds. They are not all created equal. The most important thing is to make sure that you’re working with a personal financial planning advisor who will put your best interests first. All insurance products pay commissions (well, almost all of them). And any time there is a commission involved, the adviser is going to have a conflict of interest. Make sure your adviser is comfortable disclosing those conflicts of interests to you so that everything is on the table. There is nothing wrong with someone earning a commission, as long as that person is doing what is best for you, not what’s best for him or her.

Contact  Mintco Financial for more information.

Mintco Financial has a team of independent and fiduciary financial advisors that work for you. NOT BANKS!

Call 813-964-7100 and speak directly to Michael Minter, Author of I-Plan book, qualified million dollar table advisor, Top 100 Financial Advisor in Tampa Bay area.

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