Caveats of Annuities

Q: I just finished reading one of your commentaries about the caveats of annuities as I have been talking to a financial adviser and considering one.

I am 43 years old, single female, physician, in practice with a group that offers no retirement plan. What I have accumulated has been through... investments in the stock market and I am also contributing to an IRA (that has a limit to what I can contribute to it)

The annuities have been recommended to me as a tax deferred vehicle as well as a "guaranteed" growth of my investment.

One of the major drawbacks I see is the annual cost of 2.75 to 3.4%, however, after reading your web page I am not sure I will be doing the right thing for the future.

A: The cost is definitely a drawback. There also aren’t the guarantees that you think. You mentioned that there is guaranteed growth. That’s not the case. Here is a link to an article where I deal with that misconception:

Are Variable Annuity Guaranteed Living Benefits Worth It?

Moreover, the main thing that you lack not having a retirement plan is the ability to contribute pre-tax dollars. An annuity doesn’t provide you that benefit. What an annuity does do is allow the earnings to grow tax-deferred, but I don’t feel that’s the benefit the annuity salespeople portray it as. The reason is because when that money is withdrawn down the road you have to pay ordinary income taxes on it. That means you pay income tax just as if it were wages from your job (no social security or medicare). That means you could be paying taxes of 35% on it if you are in a higher bracket. Annuities also cause you to lose access…that money has to remain in an annuity until 59 1/2 or you face automatic IRS penalties.

On the other hand, you can instead invest that money in stocks, bonds, mutual funds, etc. and the dividends and capital gains are taxed at a maximum rate of only 15%. My calculations show that the tax-deferred annuity will never result in more after-tax income if taxed at a higher rate like 35%. On stocks and mutual funds you can write off any losses on investments, you can’t in an annuity.

This is probably money that you want to put away for retirement. That doesn’t do away with the negatives associated with keeping the money in an annuity until 59 1/2. For instance, what if you don’t like annuities or find that they aren’t the investment you thought? With an IRA, you can transfer that money into an IRA at a brokerage account and invest in stocks, mutual funds, CD’s... virtually anything. If you go the annuity route you can only move the money from one annuity to another.

To me, the "benefit" of tax deferral doesn’t outweigh that risk.

In short, I don’t believe an annuity is the best choice.

The more you understand about the financial services the better you will be able to protect yourself. Here’s a link to a Special Report I’ve written that deals with that subject. It also talks about the uncommon strategies and services I provide to common investors.

Financial Self-Defense

Let me know if I can be of further help. I’d be happy to talk to you about the strategies I would recommend in your situation.

Your posted comments on this and other questions are welcome.
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