Is my AAA financial advisor's advice to invest in an annuity a good idea?
Should I consider investing in an annuity or stick with my long-term stocks if I don't like the unreliability of the market?
I am 48 years old. My AAA representative has suggested that I open up a fixed-index annuity. It would be a 10-year annuity with a 5 percent cap and no fees except for early withdrawal. The insurance group that they work with has a financial S&P rating of A+. With the unreliability of the NYSE, I've lost $25,000 over the last month. I don't know much about annuities, but I want to have something with reliable interest and less volatility. I am going to deposit about $75,000. Alternatively, a 10-year CD performs worse even with 3.15 percent interest and fees. Should I consider the annuity, or stick with my long-term stocks?
Joshua Escalante Troesh CFP | MBA
Staying invested in the stock market will give you a significantly higher potential return, even with the recent market volatility. While annuities provide for protection against losses, they do it by taking most of the potential gains and giving those profits to the insurance company. And although there are no investment management fees, annuities have other internal fees (typically 3% to 7% annually) hidden within the annuity contract.
Get a Second Opinion
If you’d like a second opinion on the annuity, you can schedule a call to talk about your goals, concerns, and how your investments or the annuity fit into your overall financial plan. Purposeful Finance, a non-profit organization, also offers a free annuity review if you would like to see how the AAA annuity compares to the option of staying invested in the market.
Questionable Advice from AAA
While AAA is an amazing company for auto-related products, they offer suboptimal financial advice. AAA is not an investment advisor and their financial advice is actually a sales pitch for insurance products. Legally, they do not have the ability to provide advice or recommendations regarding anything other than insurance products.
The advice to switch to an annuity after the 'losses' occur is questionable at best, as you would be locking in those losses and locking out potential recovery. The 5% cap also seems very low, even for an annuity, which would further limit your future growth.
Additionally, you want to consider the source of the advice to open up the annuity. AAA financial advisors are agents of an insurance brokerage, meaning their legal duty of loyalty is to the insurance company, not their clients. Only Registered Investment Advisors are legally held to a fiduciary duty with their clients. Further, agents are paid by commission for the annuities they sell (as much as 10% of what you 'invest'). While AAA is an amazing organization, their financial advising service is conflicted. You may wish to get a second opinion from a fee-only and fiduciary financial advisor.
Better Advice - Talk With A Fiduciary Advisor
A good financial advisor should focus on your goals and a comprehensive plan to help you achieve them. A component of that plan should be a portfolio within your risk tolerance, which you can stick with, even during market volatility. While you may not be comfortable with the unreliability of your current portfolio, adjusting the portfolio to lower the risk is likely a better answer.
At 48 years old, you have plenty of time before retirement for the market to recover. In 2008, investors lost nearly half of their wealth in the market crash. But since then, those who didn't sell their investments saw their investments recover all of those losses and then continue to grow another 100% over the next 10 years. So long as you don't sell your investments, the "lost" $25,000 is likely just a temporary dip.
Annuity Pros & Cons
The Pros of an Annuity
With a fixed annuity, the fact the insurance company is taking on most of the investment risk is a big plus. And once your retire, buying an annuity might be a good choice for a portion of your retirement funds to provide you with your basic living expenses. Realize though, that Social Security provides the same benefit, so an annuity may not be necessary to provide for your basic living needs.
And Now for the Cons of an Annuity
Annuities have very low rates of return built into them, and over long time periods generally will pay out less retirement income compared to a balanced portfolio of stocks and bonds.
Annuities also have very high costs built into them, further reducing the payout relative to the potential payout of a well-managed portfolio of stocks and bonds.
Annuities don't allow you to easily change investments once you begin the contract. Withdrawal fees are significant and can last more than a decade.
The tax advantages of an annuity are over-sold and are significantly less than the tax advantages of an IRA or 401(k) plan. Until you max out your retirement contribution limits, you are better off tax-wise with an IRA or 401(k) plan.
Internal fees with annuities are very high, and hidden upfront commissions may be taken from your initial invested principle or repaid through lower returns.
Retirement income from most annuities aren't adjusted for inflation, so what seems like plenty of money at the beginning of your retirement will likely leave you in financial hardship toward your later retirement years. There are inflation adjusted annuities but you'll see a significant reduction in the monthly income they pay you (as much as a third or greater reduction).
Insurance companies can and do go out of business, and if the insurance company you chose goes out of business your annuity income will likely be greatly reduced or be eliminated altogether.
Annuity sales practices can be very predatory, and a bad annuity advisor (sales rep) can easily lead you to believe something which isn't true. Annuity sales practices have often been identified by regulators as problematic and anti-consumer. And these annuity sales practices are one of the main reasons the Department of Labor attempted to implement their fiduciary rule.