Critical Thinking & Analysis Will Serve You Well

One of the most important actions to take when considering how you want to invest your retirement savings is where to invest your money to benefit you the most. When using a financial planner, always ask about the fees and commissions each investment vehicle charges and how that impacts your return. You will always pay a fee, but you need to reduce the impact of those fees by trying to lower them through your choices. This is just common sense. That is why when I was asked the following question, I tried to help the person use critical thinking and analysis to guide her along to self-discovery.

She asked “My financial planner has been talking to me about annuities. The guaranteed return looks attractive, but I am still concerned about not having enough in retirement. What would you suggest?”

First, I would ask you to tell me how much you know about annuities. In general, annuities are savings accounts with insurance companies. I find that many people hear “seven percent guaranteed return” and never ask another question. It is akin to hearing the doctor say you have cancer and never hearing another word he says because of the shock of hearing the word cancer. In an environment where interest rates are near zero, seven percent sounds good. But ask yourself, if the banks are only giving a percent or two in interest, how can an insurance company guarantee seven to ten?

They can guarantee that kind of return because they make much more than that on your money. Insurance companies invest the assets of an annuity in the market and produce greater returns than they pay out. That is the only way that equation can work if they are going to stay in business. Now I am not mad at those who sell annuities nor do I dislike the insurance salesman, but I don’t think they fully disclose why they steer so many people towards them. There are two primary reasons for this advice. First, as I stated, the return on the assets is greater than the promised seven to ten percent and second, the fees and commissions for annuities makes them money.

Annuity commissions are some of the highest commissions in the investment world. Partly because of the potential for those assets to generate return for the company. So annuities will give you piece of mind when an annuity contract promises seven to ten percent annually, but you will also reduce the ability to build wealth by believing that an annuity is a wealth producing vehicle.

Seven percent barely surpasses taxes and inflation. Inflation is historically three percent and depending on your tax bracket, you could be paying out thirty-nine percent when you withdraw the money from a qualified annuity. Bye-bye seven percent. This is also why the insurance companies can guarantee that you never lose your principle, because the inflow of new clients provides enough liquidity to cover losses.

I am not suggesting that you should never get an annuity. If you have everything else covered and you just want to do something different with your extra assets, why not get a guaranteed return of seven to ten percent? However, I would not start there with rollover pensions or 401k plan assets. I would only do an annuity in special circumstances.

The key thing to understand about an annuity is that it is, first and foremost, a contract with an insurance company where you give them a set amount of money and they, in turn, pay you interest on that money for a pre-determined period of time. This interest payment is the seven to ten percent you see offered. The big risk, and one that is more possible than probable, is if the company goes bankrupt, you could lose everything.

When deciding whether or not to purchase an annuity contract be sure to read the fine print and ask the right questions. Questions such as “If I buy a lifetime annuity and I pass away after three years, what happens to the principle?” In some cases, the remainder of the initial invest is gone and cannot be passed down to your children.

As I said, I would only consider an annuity as the last piece of a fully operational retirement strategy. I would never use it as the primary vehicle of choice to fund your retirement plan. However, all financial decisions are personal so I am not suggesting that you should or should not enter into an annuity contract. Just use wisdom, critical thinking, and analysis before you do.