An annuity is rarely sought out byinvestors but instead is boughtafter someone has "pitched" theproduct. The following are some of myconcerns for this product:
•Annuity products tend to havehigh fees and many entail large up-frontcommissions as well.
•Many of the annuities sold arevariable annuities, which allow you toinvest in a variety of both stock andbond mutual funds. When you do this,you will ultimately convert what mighthave been long-term capital gains (taxedat a maximum federal rate of 15%) intoordinary income (taxed at a maximumfederal rate of 35%).
•Some annuities are sold in IRAaccounts, which means you have placeda sheltered investment inside anothersheltered investment, resulting in anunnecessary layer of fees.
Having said this, annuities are impossibleto ignore, and insurance companiesoffer enticing options, includingthe following:
•Fixed vs variable annuities.With a fixed annuity, you will receive aguaranteed interest rate for a period oftime. Many companies offer aninitial "teaser" interest rate. This teaseris an attractive rate compared to currentinterest rates and is typically guaranteedfor 3 to 5 years. After the teaser rateends, the new rate may not be competitive,but you will be unable to switch toa more competitive company because ofstiff surrender charges.
•Guaranteed retirement incomebenefit. Typically the insurance companyguarantees that at the time youconvert your annuity into a lifetimeincome, the income will be based onthe higher of the account values—netpremiums accumulated at a predeterminedrate of return or the highestvalue on any contract anniversary. Thesales pitch says that your retirementincome will at least be based on premiumspaid in plus a reasonable return.Before this rider becomes effective, youtypically must keep the policy in forcefor a minimum of 10 years. The insurance company may includelanguage that alters the retirementincome payments under this benefit. Inother words, how your payout is calculatedunder this benefit may result inlower lifetime payments than an actualaccount value of the same size.
Stewart H.Welch III, CFP®, AEP, is the founderof the Welch Group, LLC, which specializes inproviding fee-only wealth managementservices to affluent retirees and health careprofessionals throughout the United States.He is the coauthor of J.K. Lasser's New Rules for Estate andTax Planning (Wiley; 2005). He welcomes questions or commentsat 800-709-7100 or visit www.welchgroup.com. Thisarticle was reprinted with permission from the BirminghamPost-Herald.