Growing up in the late 60’s and early 70’s we took vacations in the family station wagon. The Ford Country Squire seemed to be the model of choice. As I remember, I think we had blue, black and beige ones all with the simulated wood paneling down the side, a truly iconic American experience.
Each of our family wagons had that dreaded third row seat that folded up in the back. Facing backwards on a long trip was not a good idea! To pass the time on those long summer trips to Utah we played a variety of road games. Looking back I think my parents promoted these games to hush the constant drone of questions like, “Are we there yet?” and “How much longer?” Remember, this was before the infamous i-pods, portable DVD players and Game Boys that my kids later enjoyed!
One of the popular road games we played was the alphabet game. You likely remember this one. The goal was to find each letter of the alphabet in sequence by observing available road signs, license plates, etc. Upon spotting the next letter you would loudly call it out. Once called, no one could use the same sign or plate, so being on your toes and having a good eye was an advantage. It was a great game except for the long, baron stretches through the California desert. Once we got to Las Vegas it was much easier especially in looking for that allusive “Q” or “Z”. Having a trained eye was certainly the key to success.
I didn’t think I would ever use my alphabet game talents in my profession, but reading annuity contracts often seems like alphabet soup. Remember, there is no perfect financial tool! Each tool has its unique purpose with inherent positives and negatives. Annuities are no different. When positioned and aligned properly with a client’s goals, an annuity is a great tool, but they have many working parts that must be understood. Annuities can safely and efficiently protect and grow assets, are tax efficient and can provide guaranteed lifetime income options unmatched by other financial instruments. By the way, I am not referring to variable annuities, which involve market risk.
Let’s jump into some annuity alphabet soup. First to consider is the contract length. Most annuities are 8-10 years long. Some worry they are tying up their money for a period of time, but if an annuity is positioned correctly a client should never feel tied in! Poor diagnosis and prescription by an untrained advisor often results in this feeling.
What about surrender charges? Surrender charges are assessed if the owner wants to surrender the annuity before the annuity matures. In the early years this could be 8 to 10% of the annuity’s value and could result in a serious financial penalty! An annuity should not be purchased if there are liquidity concerns.
To combat surrender charges, most annuities have an annual 10% penalty free withdrawal, allowing the owner to withdrawal 10% of the annuity’s value each year without penalty. This provides increased liquidity and is often overlooked.
Another feature is annuitization, meaning how a particular annuity converts to income. Annuities are terrific income producing vehicles, but they are not all made the same. Can you annuitize while in the surrender period? What payout options are available? Is partial annuitization permitted and at what rate or formula?
What about hidden fees? Sometimes unnecessary riders are purchased with fees charged to the accumulation account. A terminal illness or long term care rider is essential, but watch for the angel or devil in the details. Caps and/or participation rates on indexed products need to be evaluated as well. When can they change? Are there bailout provisions? These are all important components to understand.
Finally, what about the carrier’s financial ratings, history, management team, and ownership structure (mutual or stock)? These are important elements in the world of annuity alphabet soup. Being in the back seat is not recommended when purchasing an annuity. Annuities are great estate preservation tools, but being aligning with your goals and having an advisor committed to education is essential to making the right selection. With increased education you will enjoy the ride and experience financial peace.