I want to talk about what I believe to be Six of the Biggest Mistakes that people sometimes make when buying an annuity.

This is part of a series that I put together that is going to go over about four or five different topics pertaining to annuities so if you haven’t seen the other videos check those out. They’re all going to be on our Youtube channel and we’re going to put those all inside of a playlist there. So you can hopefully get some good information.

When it comes to buying an annuity I believe that there are few mistakes that some people make from time to time. There’s actually six of these mistakes and I’m going to talk about those now.

The number one mistake that I think people make is not understanding the surrender periods.  Annuities are intended to be long term investments, and most annuities have some type of a surrender period. Probably the most common period that I see is a seven year surrender. But sometimes they can be a little shorter. Sometimes four years, sometimes as short as a year or less. Sometimes they go out 10 years. I’ve seen some crazy ones that go all the way to 15 years. But seven years tends to be the most common. What that typically means for a person buying an annuity is that if you take the money out of that annuity within that seven year time period you could be faced with an early surrender penalty. Sometimes it could be 8%, sometimes it could be more than that. And then generally it declines a little bit each year as you get closer to the end of that surrender period. So it might be, let’s say, 8% in the first year if you take a withdrawl. It might only be three or four percent or two percent if you take it out in the last year of your contract. So pay attention to that.

Most of the time annuities do have what’s called a free surrender amount. Most common that I see there is 10% so the way that works essentially is if you put $100,000 into an annuity you might be allowed to take out up to 10% or $10,000 out of that annuity even if it’s within that seven year surrender period. But that’s mistake number one. A lot of people don’t understand that surrender period.

Number two mistake, and this is one I see all the time, and that’s mistaking the guaranteed benefit base growth for a guaranteed account value or principal value guarantee. So what do I mean by this? Well a lot of annuities, depending on what type of annuity we’re talking about, keep track of two things, your actual account value which is going to be dependent on the specific investments that are in that annuity, or whatever that annuity may be tied to. But they also might keep track of your benefit base. Sometimes it’s like a living benefit essentially. They might have a guaranteed rate of growth on that living benefit. And a lot of times people mistake that for the actual account value. So that is not an amount that you can actually walk away with. It is actually just used for income purposes. Which is still not a bad thing. Probably a good thing. That’s why you bought the annuity was for income purposes. But those are not the same things so be extra careful to understand the difference between the contract value and the guaranteed benefit base value.

Number three is fees. You really want to ask questions. Some annuities can have pretty high fees. Especially if you’re talking about a variable annuity. Fees can easily be in excess of 3% per year. And these fees kind of fall into a couple of different categories. Most annuities have what’s called an M&E charge. It’s called mortality and expense as a base cost. They also might have a rider cost on there too. Especially if you bought anything that had a death benefit feature or a living benefit. You may be paying an extra fee for that rider cost. And in the case of a variable annuity there will be some costs with the actual investments as well. So you could have three different components of fees that could add up. And then on top of that you could even have a contract fee as well that might hit your account every year. So make sure you ask the right questions and as your advisor is describing the fees. I would always follow that up with “Are there any other fees that I should know about?” And maybe have them list those fees out so you know exactly what you’re paying. And it still may be totally worthwhile. Those fees justify the benefits that you’re going to get from that. But you want to know what those fees are and a lot of people that I see don’t really truly understand what those fees are.

The fourth mistake that I see a lot of people make is not adding their spouse onto a living benefit rider. One of the purposes that a lot of people buy annuities is for some type of a guaranteed income. And annuities can do a pretty good job of that. That’s one of the primary reasons that people buy annuities. But what I see a lot of times is that people don’t add their spouse onto the income benefit. And that may be your intention. Maybe there’s a reason for that. But most of the time if you’re married you want to have your spouse added on there. And usually the way those spousal income benefit features work is they will continue to pay those guarantees out as long as either one of you are alive. So if you pass away early, your wife or your spouse will get that. Or vice versa. And usually you give up a little bit of income by adding your spouse on. Maybe you get a half percent less in terms of the income benefit. But again, it’s something that I think is totally worthwhile and if you’re basically buying that annuity for that long term guarantee of income you want to have your spouse on there as well.

Number five, and this is another big one too, is that thinking your annuity is going to get you stock market-like returns. I think this is one of the reasons that a lot of people may find that they’re not happy with annuities. And it may be one of the reasons a lot of people talk negatively about annuities because they’re comparing these annuities to what returns they could potentially make in the stock market. And that’s just not probably going to happen in my opinion. You know, I think that an annuity in my opinion should be used as more of an income replacement. It’s intended to be maybe the safer part of your portfolio. So if you think of that traditional retirement 60/40 split where maybe 60% of your assets would be in stocks and 40% would be in bonds. Maybe it makes sense for an annuity to be part of that 40%. You know, here we are the 10 year treasury I think is now at somewhere around 2.3%. So if you think about that that’s a pretty low yield for something that you’re locking your money up for 10 years, in the case of the treasury. And if interest rates go up that could actually cause some principal value to go down. So a lot of people are searching for some alternatives to more of the traditional fixed income and annuity might do that. But don’t expect it to get the kind of returns that the stock market gets. Even if you’re buying, for example, an index based annuity where it may be tied to the SNP. Usually there’s going to be some caps or some spreads that are going to come into that and it’s going to reduce or knock down that potential yield there.

The final mistake that I want to talk about is the bonus. And this is something that is, I call it a tactic I guess. But a tactic to encourage people to buy the annuity where you’re going to get a bonus for buying it. So you’re going to put $100,000 in and maybe you get a 6% bonus for buying it. So your $100,000 right off the bat becomes $106,000. You know, and so it sounds very appealing but you have to think about it. Why is this annuity company giving you $6,000? It’s just not to be nice out of the kindness of their heart. There’s a couple of reasons for that. One is that 6% annuity, we’re just using that as an example is going to probably be applying to your benefit base. So it’s not a walk away value that you’re going to be able to take that money out. It’s going to be to help the amount that you’re going to get for your future income let’s say. And the other reason is that the expenses on a bonus annuity are typically much higher than they are for a non-bonus annuity. So essentially if they’re giving you 6% up front it’s only because they’re going to collect more in fees from you over the lifetime of that annuity. And they might do that through actually higher fees as a percentage. Or they might do it by locking you into the contract longer. So instead of a seven year surrender it might be a 10 year surrender or 12 year surrender. So, I have never personally worked with a bonus annuity with a client. It’s just not something I believe in. I think it’s basically a pre-payment of the fees the annuity company is essentially going to collect from you down the road anyway.