Are Fixed Annuities a Good Investment? 5 Warning Signs of a Bad Annuity

An annuity is a financial product that allows individuals to make an upfront payment or a series of payments in exchange for a steady income stream, often used for retirement. While annuities can provide a reliable source of income, they come with potential downsides such as high commission fees and complex contracts.

Before committing to an annuity, it’s important to be aware of some key warning signs that could indicate a less favorable investment.

An annuity is essentially a contract with an insurance company that guarantees a regular income over time based on the amount you’ve paid, either through a lump sum or periodic payments. There are various types of annuities, such as variable, fixed, and indexed, each with its own set of benefits and drawbacks.

To make an informed decision, here are five red flags to watch out for when considering an annuity.

1. The fees are too high

Annuities often come with various fees that can impact your overall returns. Variable and indexed annuities usually carry the highest fees, while fixed and immediate annuities tend to have lower costs. Typical fees include:

• Commissions: 1% to 8%
• Administrative Fees: 0.3%
• Surrender Charges: 0% to 10%
• Mortality Expenses: 0.5% to 1.5%
• Expense Ratios: 0.06% to 3%
• Riders: 0.25% to 1%
• Rate Spreads: 2%

The exact cost will vary based on the type of annuity and the specifics of your contract. If the fees proposed in your annuity contract are significantly higher than these ranges, it may be a red flag. Excessive fees could substantially diminish your returns or make the annuity less advantageous compared to other options.

2. The annuity is poorly managed

Annuities can sometimes be associated with high sales commissions for brokers, which might lead them to recommend products that aren’t in your best interest. Signs of poor management include:

• Lack of transparency in performance reporting
• Poor communication from the fund manager
• Difficulty accessing customer service

Additionally, if the underlying investments are unstable or risky, or if the managing company has a poor financial rating, these factors may indicate subpar management. Be cautious if you encounter these issues, as they could affect the quality and performance of your annuity.

3. There’s a long surrender charge period, or the charge is too high

Annuity contracts often include a surrender charge, which is a fee you pay if you withdraw funds or cancel the contract before a specified period. Surrender charge periods commonly last between six and eight years, with charges typically starting around 7% or more and decreasing over time.

If you find an annuity with a surrender charge period exceeding 8 to 10 years, or if the charge is higher than 7%, it may be a sign of a less favorable contract. Such lengthy or high surrender charges can make it more difficult and costly to access your money, indicating that the annuity may be more restrictive compared to other options.

4. The annuity has poor returns compared to other investment options

Variable and indexed annuities often have returns tied to market performance.

• Variable Annuities: Payouts depend on the performance of selected investments, such as stocks and bonds.
• Indexed Annuities: Payouts are linked to a financial index, such as the S&P 500 or Dow Jones Industrial Average.

To assess an annuity’s attractiveness, review its historical performance and compare it to other investment options. Check the returns of the mutual fund-like subaccounts for variable annuities or the credited interest for fixed or indexed annuities. This information is typically available in the annuity’s prospectus or quarterly statements from the insurance company.

If this performance data is difficult to find or lacks transparency, it may indicate a problematic annuity. Reputable companies usually provide performance details on their websites as well.

5. The income agreements are vague or unclear

A major red flag with an annuity is if the income terms in the contract are vague or unclear. If the contract lacks detail about how much income you’ll receive, when it will be paid out, and under what conditions, it’s best to look elsewhere.

Annuities can often have complex language, but there’s a difference between intricate wording and deliberately omitting crucial information about your potential income. Watch out for contracts that do not clearly specify:

• How income will be calculated
• The impact of various factors on performance
• Whether income is guaranteed for life

In Conclusion

Annuities are complex financial products and may not suit everyone’s needs. It’s important to weigh the benefits and drawbacks with the help of a financial advisor who understands your financial goals and investment strategy. Be cautious of warning signs such as unclear income agreements or excessively high fees compared to other annuities.