InsuranceInvestmentRetirementTax

5 things to know before investing in annuities and similar products

By July 23, 2020 January 23rd, 2021 No Comments

As you may already know if you’ve been watching my YouTube videos, my goal is to educate you, and give you the tools to become financially successful here in the US, whether you are American or an Expatriate now living in the US. As always, feel free to reach out to me using my email : theo.desmulier@raymondjames.com or by phone : (407) 478-0374.

In the last few months I’ve met quite a few people who owned annuities or similar investment products. They had a lot of questions for me, since most of them didn’t have a solid grasp on the contracts involved, the internal expenses they were paying, or even why they had been encouraged to buy these products. This often happens when the client trusts their advisor beyond questioning.

Another reason annuities cause this kind of confusion is that they are very complicated and difficult to understand. It’s your advisors job to educate you so that you feel confident and secure working with them. They should be earning your trust, not just expecting it.

In this article, I will talk about what you need to know BEFORE you engage in a variable annuity, a wealth accumulation life insurance, a whole life insurance policy, a universal life policy…, etc.

Learn more about the different types of Life Insurance here: https://moneywiththeo.com/2020/03/life-insurance-as-a-us-resident-expatriate-in-the-united-states/

People buy annuities because they are a great tax planning tool for higher net-worth investors who have already maxed out other financial account opportunities. If you currently own an annuity, you may be able to take out your money, but it’ll likely cost you to break the contract early.

1. Understand what is being sold to you

Annuities are a tax-deferred product that’s intended to provide a steady income stream for your retirement. There are hundreds of types of annuities out there, but for the sake of simplicity, I will speak in general terms. If you would like to know more about the types of annuities, I suggest you look into the following Investopedia article:

https://www.investopedia.com/investing/overview-of-annuities/

Be wary of what seems to good to be true!
Too often I meet with a prospect who is very happy with her current situation; and even feels that she completely understands her investments in and out. After I ask a few questions, that confidence tends to dissipate.

Your financial advisor may be someone you know, and therefore trust. You may think he has your best interest in mind. This is unfortunately when a lot of people enter into problematic contracts. For example, if your advisor encourages you to invest in any sort of money-locking product right off the bat, you should question this advice. 99% of the time, it’s not the right product for the client.

Something to keep in mind: advisors generate a large and immediate commission for selling you these types of products. Other, usually much safer, products generate a slower, steadier commission for the advisor and require more management (work) on their part. There is a reason why the industry as a whole is developing more regulations related to these products and the clear conflict of interest.

Has your advisor properly educated you on how your investments really work?

If so, great! You can skip to the next step. If you have any doubts, then you should really reach out to your advisor and ask the right questions.

2. Consider the issuer

An issuer is the entity that issues the contract for you.

If your money is locked for the next couple of years, you want to make sure that the carrier will take care of your money for the indicated period, and not default. You should know what this carrier specializes in, and why it’s the best fit for your needs. Make sure that the carrier has been around for a significant amount of years and that it has strong records of good practices.

3. Consider the surrender charges, or early withdrawal penalties

Annuities and similar accounts lock your money, meaning, you cannot move it without incurring fees. There are plenty of investment options that do not lock your money or charge you to move it. Again, a major reason these accounts are pushed on clients is the massive commission the advisor receives compared to other arguably better accounts.

Your advisor may not have access to these options, however. Different license types restrict the products advisors are able to offer. With my licenses, I am able to offer a wide array of investment products, which allows me to choose the product best suited for my client.

This is really one of the most important things to focus on: is there any possibility that you will need or want access to this money in the next 5, 7, 10 years? If the answer is yes, then I would strongly suggest steering clear of any products that will lock your money.

If the answer is no, and you have run out of all other opportunities, then this product may suit you.

With this considered, you need to understand that if, for whatever reason, you wish to withdraw your money within the contract period, then you may face a huge surrender fee (usually 10%).

Briefly, here are the things you can do if you are facing surrender charges:
– Wait for the period to be over
– Look at the « annual penalty free » portion of your contract, you will be able to move some of your assets to another account more liquid (usually 10-15%)
– Understand and set up your underlying investment objectives according to your situation, risk tolerance and goals
– Explore a 1035 exchange under the tax code, this may allow you to have access to a more suitable product

4. Consider all of the associated fees

Annuities and similar contracts usually provide very attractive returns. This is why investors fall for it.

However, internal fees affect your returns. Insurance companies have made it very difficult for investors to really understand how much they are netting on a yearly basis. Your net return is your gross return minus all of the associated expenses of your account.

Gross Returns – Account Expenses = Net Return

Something I do with my clients is directly call the 800 number of the insurance company, to understand really how much they are paying. By asking the insurance representative the following questions, my clients and I have a clear and simple explanation of their cost:

– What is the insurance charge, i.e. mortality and expense (M&E) fees?
– What is the management fee?
– What is the rider fee?
– Are there any other fees? If so, what are they and what is the cost?

5. Understand your Tax Planning strategy

Like most IRAs – with most annuities, your earnings will grow tax-deferred and thus you will have to pay ordinary income taxes on the distributions during your retirement. You can learn more with the PDF below.

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The bottom line is: before buying extremely complex and opaque products, make sure that they are suitable for you. There’s a lot more to learn about annuities, and if you need guidance, you can consult an independent financial planner who has your best interest in mind.

As always, feel free to reach out to me using my email : theo.desmulier@raymondjames.com or by phone : 321-947-5445.

Any opinions are those of Theo Desmulier and not necessarily those of RJFS or Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.With variable annuities, any withdrawals may be subject to income taxes and, prior to age 59 1/2, a 10% federal penalty tax may apply. Withdrawals from annuities will affect both the account value and the death benefit. The investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. An annual contingent deferred sales charge (CDSC) may apply A fixed annuity is a long-term, tax-deferred insurance contract designed for retirement. It allows you to create a fixed stream of income through a process called annuitization and also provides a fixed rate of return based on the terms of the contract. Fixed annuities have limitations. If you decide to take your money out early, you may face fees called surrender charges. Plus, if you’re not yet 59½, you may also have to pay an additional 10% tax penalty on top of ordinary income taxes. You should also know that a fixed annuity contains guarantees and protections that are subject to the issuing insurance company’s ability to pay for them.