Have you ever asked, “Why does this have to be so complicated?”. All too often, we meet with people who have been sold expensive, complicated financial products that they really don’t need. And many of these products have long waiting periods before they can access the majority of their money without penalty. So why were they sold an investment product that is complicated and riddled with expenses and surrender charges in the first place?
For one, annuities sound really good. There’s something magical about the word “guaranteed”. People will pay a lot more for a product that says “We guarantee you will get a paycheck every month for the rest of your life” versus “We will manage the risk in your investments and the amount of your monthly withdrawals to provide a very high likelihood that you won’t run out of money.” Big difference – right? And running out of money is the number one concern many retirees have!
Second, commission-based financial advisors have a strong financial incentive to sell them. Many annuities pay sales commissions to advisors of 5 – 7% or more.
The problem is that when we do the math on certain types of annuities, we find that not only are investors complicating their financial lives, but they can wind up severely limiting the growth of their investments due to the higher expenses of an annuity. As an example, we looked under the hood of the most popular annuity owned by individual investors (roughly $116 billion in assets) and it wasn’t pretty.
We found that after adding up all of the different expense charges (Mortality and Expense, Administrative, Living Benefit Rider, Death Benefit Rider, and Investment Cost) the total charge was 4.47% per year!
So, while the insurance company is guaranteeing you will not outlive your money, they are doing so with a hefty price tag. Consider what that 4.47% means. It means that you have to earn 4.47% a year just to break even on the fees that are being charged. So even if the annuity has excellent investment options inside of it, you would have to earn 8.47% to achieve a 4% rate of return.
So what should you do? First of all, you should know if your advisor will receive a sales commission on any product they recommend. To learn more about how financial advisors get paid, check out this article. While annuities can make sense for a portion of people’s assets in certain circumstances, our preference is to avoid them. Keep it simple! Work with your advisor to determine an appropriate risk level for your investments. Once you’re comfortable, your advisor can help you structure an income plan from your investments to last your lifetime. Of course, you will still have investment expenses, but they won’t be anywhere near 4.47%! To get to know Milestone and see if we are the partner you are looking for, check us out here.