Scott reed

I was sitting on a panel at a conference a few years back. Someone in the audience came to the microphone and said, “Mr. Reed, I have heard you speak a few times. I know you hate annuities. But why do you hate them?”

I responded a bit flippantly, “I never said that I hate annuities. I think annuities are the perfect investment for about 10% of the people that own them.”

I had a reader call me two weeks ago and ask me if I would write something about annuities, so I guess I will try to explain the statement I made back then at the conference as a response to the reader’s request.

First of all, an annuity is simply a wrapper that you can put investments into. For instance, you can buy an S&P 500 fund in your taxable brokerage account, your IRA account, or your annuity. There is no difference in the fund that you bought, simply the type of account you put it in. So why do so many people like annuities?

Well, they sound good. Annuities come with all sorts of investment options and guarantees. All of your annuity investments are tax deferred, just like your IRA. Annuity companies also guarantee that your money is safe or they will make you whole. Just remember, they don’t mean safe from rises and falls in your investments, they mean safe from fraud and dishonest acts.

Annuities will allow you to annuitize your annuity. That means that they will guarantee you a certain amount of money that will be paid to you until you die. You can have it paid until your spouse dies too, but that means you won’t get as much each month.

And lastly, annuities are in most states, protected from litigation. So, if you get sued, they probably can’t get your house, your retirement plan, or your annuity.

So, what could possibly be wrong with an investment like that? There is the rub. In order to have all of these wonderful benefits, you have to pay a heck of a lot of money. Most of it you will never see as it is hidden in management fees, marketing fees, 12b-1 fees, etc. And a lot of those fees go to brokers to sell annuities to their clients.

Annuity companies also know that when they guarantee all of these things they could take a real beating in the short-term, so many of their products have back-end fees that make it almost impossible to get your money out if you need it in the first 5-10 years.

Annuity companies also know when you are supposed to die. You may not oblige them, but they know the numbers. So, when they guarantee you money for life, they have to make sure they make their money too. If you live to be 110, you win. If you die five years into your annuity, they win.

Let’s be clear. There is nothing wrong with what they do. They are offering you benefits that take risk off the table and they are getting paid handsomely for it. The problem I have is that the incentive to sell annuities is so great and they sound so attractive that they get sold to a lot of people that don’t really need to pay for that risk mitigation.

There are a lot of people who would benefit from having an annuity. People who are in a job where they might get sued. People who don’t have the ability to manage their own investments. People that want to benefit someone else without letting them have access to the principal amount. People that have a long time until they retire and want to put away more than they can through traditional methods.

Just remember that you will pay a lot for the privilege of owning an annuity so make sure you are one of the 10% that I think really need it.

Be careful out there.

Scott Reed, CIMA, AIFA, PPC, is CEO of Hardy Reed LLC in Tupelo.

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