The 7 Costly Mistakes People Make with Their Money (Mistake # 7 – Part One)

The 7 Costly Mistakes People Make with Their Money (Mistake # 7 – Part One)
July 3, 2014 Pat Berg

With pension plans going the way of the cattle prod, a retirement plan that includes a predictable stream of income for the rest of our lives is a no-brainer. And there is only ONE financial tool that can accomplish this: The Annuity!

Many people react to this by saying, “I keep hearing how I should ‘max out my 401(k) plan, invest in growth mutual funds, buy term life insurance, and invest the difference’… I never hear anything positive about annuities.”

Just because everybody’s telling you to follow the herd, doesn’t mean YOU should.

No matter what either side of the aisle—Wall Street or insurance companies—are preaching, at some point, the majority of retirees “must” have a guaranteed source of mailbox money. It’s that simple.

While annuities have been around for over a century, there is nevertheless a ton of misinformation about them. Here are Misconceptions #1 – 5. Misconceptions #6 – 10 will be covered in Part Two of this article.

Misconception #1: Annuities come with huge surrender penalties.
Surrender penalties are nothing more than a “penalty for early withdrawal.” It is there to not only protect the annuitant (the title given to the person placing their money—premium—with an insurance company annuity), but also to protect the insurance company. Let’s face it; the last thing you need to worry about is the insurance company going belly-up. The more the insurance company is willing to promise (interest rate, income, etc.), the longer you’re going to have to leave the money with them to avoid surrender charges. Surrender penalties within the annuity allow the insurance company to protect themselves from people making a run on the company, thus guaranteeing that your annuity is safe and secure, and the insurance company can continue to meet the contractual obligations made to their annuitants.

Holding onto your money and putting a penalty for early withdrawal is nothing new; banks do it all the time. Just take a look at CD rates: the longer the maturity, the higher the interest they pay for your money. However, with these higher rates comes the possibility of higher surrender penalties to you if you get out early.

Misconception #2: All annuities charge high fees.
Nothing could be further from the truth, unless you are referring to variable annuities. Variable annuities, which are sold mainly by Wall Street, are mutual funds in an annuity wrapper. The reason variable annuities charge higher fees (as opposed to fixed annuities) is due to the risk of the stock market within them. While a variable annuity can make huge returns (based on the success of the market), it requires the insurance company issuing them to charge fees in case things don’t pan out (the market crashes and you want to guarantee either a lifetime income and/or something for your family when you die).

Fixed annuities, on the other hand, are not invested in the stock market, but instead invest in portfolios of safer instruments like corporate and government bonds. The insurance company issuing fixed annuities makes their money (profit) on the spread between their overall bond portfolio and what they can pay you on the balance after deducting their expenses.

Misconception #3: Annuities are difficult to understand.
There are various articles filled with misinformation regarding annuities (obviously written by people who have little understanding of annuities and/or are too lazy to take the time to read the contracts) as they go on-and-on about the complexities of annuities.

Just because someone has limited knowledge of how a TV works, doesn’t mean that they shouldn’t watch their favorite programs.

Regardless of whether you’re 25 or 75, if you are looking for an investment that will give you guaranteed mailbox money in retirement, you should thoroughly research and consider an annuity. For retirement-minded folks who are more concerned about the return “of” their money AND a guaranteed return “on” it, it is the way to go.

Misconception #4: With an annuity, my money is tied up.
While the vast majority of annuities come with surrender penalties, most still offer flexible ways to “untie” your money so you can use it. Here’s a few:

  1. Beginning after the first month of the contract, you can request the insurance company send you the interest earned.
  2. After the first full contract year, you can request 10%—without penalty—of the entire contract value, each and every year. In some annuities if you skip taking the 10% one year, you can take 20% the following year.
  3. If you are diagnosed with a terminal illness or go into a nursing home, most will allow you to take out more than 10% penalty-free each year.
  4. Upon your death, the full value of the annuity will be paid to anyone you choose, with no penalty whatsoever.
  5. At the end of the surrender term (usually 5 to 16 years), you can cash out the entire annuity value at no penalty whatsoever.
  6. You can annuitize (usually at any time) and begin receiving a lifetime monthly income without penalty.
  7. If your annuity contract has a “guaranteed lifetime income rider,” you can begin monthly income payments when you choose and even change your mind later and take the remaining annuity value in a lump-sum cash payment (newer feature which differs from annuitization).
  8. And finally, you can “cash out” your annuity at any time if you’re willing to deal with the surrender penalty. Of course, if you cash out the annuity after the surrender penalty expires, no problem getting all your money back (unless you are in a variable annuity and then, your account value could be less than you put in based on the market value).

So, as we can see, the right type of annuity is very flexible and accessible at any time as long as you use it appropriately.

Misconception #5: Nothing is left for my family when I die.
This is only true if you “annuitize” your annuity and elect the “life only” option. Sometimes people select the “life only” option, as opposed to other options with annuities that offer a survivor option upon death, because they need the highest income payout possible. (The “life only” option is the same option given to retirees who have had the luxury of an employer-sponsored pension plan.) You can do the same thing with most annuities… and only an annuity—not a stock, bond, mutual fund or other non-annuity investment—has this feature.

So if you DO NOT annuitize the annuity, your family is assured of getting what remains of the annuity at your death (unless of course, you simply take withdrawals during your lifetime or surrender the annuity and do something else with it—which you can certainly do).

These are just some of the common misconceptions about annuities that are out there. More will be covered in Part Two of this article, which will be published next month.

Be sure to talk to your financial advisor about your retirement options, especially annuities. You’ll be glad you did… and will most likely worry less about your retirement as a result.

The Retirement Pros (Tony Walker, contributing author)
July 2014

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