Disadvantages / Annuities
However, the advantages are NOT the only thing the consumer should know about the annuity. There are disadvantages to owning an annuity and the consumer should know these as well at the onset prior to purchase. However, these DISADVANTAGES can help separate you from a few financial professionals they have met in the past since YOU are "informed".
As a result, they will be informed, a lot more informed.
- Increasing Interest Rates
In an increasing interest rate environment, interest rates that many traditional fixed annuities pay in renewal years do not tend to increase as rapidly as the market. This potentially could affect the senior more since they could be on a fixed income during an inflationary increasing interest rate environment. One solution is to diversify more so that the money that they have in the bank can react to increasing rates and the annuity could help them in a decreasing or level interest rate environment.
- 10% Tax Penalty
Annuities are designed for the long term and there can be a 10% tax penalty for dollars withdrawn before age 59.5. One solution for the pre-59.5 year old is to have access to non-annuity dollars if money is needed.
- Renewal Rates
Some insurers have not paid competitive renewal interest rates and renewal participation rates. Since initial current interest rates are not guaranteed forever nor are the participation rates for some Fixed-Indexed Annuities, you might want to review the history of the product and company you are offering.
- Surrender Charges
Some annuities have longer surrender charge periods than others. This potentially could affect seniors more since they may have more needs than younger consumers. For example, a $50,000 surrender from an annuity with a double digit surrender charge could generate a surrender charge penalty of $5,000 or more. On the other hand, if they had kept that $50,000 in a money market account instead, then there would NOT have been any surrender charge penalty. This is another great example as to why it is so important for us to discuss diversification with the consumer and the wisdom of having taxable, tax-deferred, and tax-free alternatives in their portfolio.
- Death Benefit Subject to Surrender Charges
Some annuities impose surrender charges against the death benefit if the owner dies in the early years. This could affect the amount of money that the beneficiary could receive if the owner were to die in the early years. One solution could be selecting an annuity that does NOT impose surrender charges in the event of death especially when the owner is a senior.
- Strength of Insurer
Since an insurance company's guarantees are only as strong as the insurer issuing the annuity, not every insurance company is as strong as the other. One way to evaluate an insurer is to read what the independent rating services are saying about the insurer. Another way is to examine how they invest their assets such as in investment grade bonds, government bonds, or real estate, etc.
- Taxable Death Benefit
The death benefit distributed to the beneficiary is subject to taxation. There are other investments that have a stepped up cost basis in the event of death like in real estate, however, annuities are NOT one of them. In other words, the beneficiary must pay income taxes on the pre-taxed dollars. For example, a beneficiary who receives the death benefit from a non-qualified annuity that has grown from $100,000 to $200,000 will have to pay income taxes on the $100,000 gain. However, as you learn later, spouses may defer taxation indefinitely and non-spouses have 5 years.
- Return of Less than Premium
Some Fixed-Indexed Annuities do NOT have a guarantee return of principal. In other words, an owner of an annuity could receive less than their premium if they were to surrender during the early years. One solution is to properly diversify so that if dollars are needed, the consumer can turn to non-annuity dollars for unexpected and expected needs.
