by Dennis Miller | June 22, 2013 8:00 am
Erik’s friends bought into the idea of buying their own pension with an annuity. They had taken large payouts from their employer and had put it all into annuities. This was back when putting your entire portfolio into annuities was still allowed.
As Erik explained, the annuities were variable and many of his friends had experienced a 30% cut in their monthly benefits after the stock market crash. At one time, his friends used to brag about how pleased they were with their annuities. Despite the praises from his friends, Erik thankfully didn’t follow their lead, and unfortunately for them, the tide turned. Their income was reduced while their expenses continued to rise.
The insurance company was totally honest and paid their benefits according to the contract. But the buyers did not understand the contract and had very different expectations. When their benefits dropped, they had to make major changes in their lifestyle.
With this story as our background, one of your first questions is most likely: why did the annuity income drop so radically? The answer is easy to understand.
Prior to 2008, if you took a lump sum investment and put it into a variable annuity, the company would take a conservative approach to investing your funds. Typically, half the funds would have been invested in quality, safe fixed-income products like CDs and top-rated bonds, which used to pay 6% consistently. The other half would have gone into the stock market.
Previously, the fixed-income side of the annuity was the safe side, and the stock market side was the less predictable, variable part. But in good times, like the run-up to the 2008 crash, even the stock market side of it could pretty safely expect a 10% return per year.
The way most people saw it, the fixed-income side guaranteed a 6% return on half the money – even if the market crashed, one would still be set.
What happened in the fall of 2008 changed that picture quickly as banks called in their CDs and interest rates across the board plummeted. AAA-bonds and FDIC-insured CDs were paying nowhere close to 6%. What was once the safe, cash flow portion of the investment capital suddenly became variable as well. The investments were technically still safe, but the once decent yield became close to nothing. And of course, we all know what happened to the stock market. So the variable side and “safe” side of the portfolio were hit simultaneously.
While the word annuity in “variable annuities” might make it sound like a safer investment, it’s ultimately not. Your money is still in the market. In fact, in some ways, it’s at even more risk.
If you simply owned your own mutual fund or fixed-income fund, you could have sold at any time without penalties; the same is not always true of annuities. With variable annuities, your money is in the market with more fees and less control – a toxic combination. Variables annuities are certainly not the same as a guaranteed pension for life.
Not all annuities are bad deals, but before you start asking for quotes on annuity products, you’ll want to do some homework. To help you get started we’ve put together an easy-to-read report called Annuities De-Mystified. You’ll find our 8-point checklist to find out if an annuity is right for you, our 9-point plan showing you what to look for when buying an annuity, and an important overview of the risks associated with annuities all within the pages of this timely, must-read report. Click here for your free copy today.
Back when I was a kid we purchased our first television. It was one of those with the small, round glass, black and white screen and poor sound quality; it looked more like furniture than advanced technology. But it was ours and we proudly watched it together as a family.
As a Chicago native I naturally watched WGN whenever I could. So imagine my surprise when they called to do an interview about my book, Retirement Reboot. Whether you live in Chicagoland or not you likely get WGN-TV Superstation on your cable or satellite system. So if you have a few minutes between 11:00 a.m. and 1 p.m. on Tuesday, June 25, be sure to tune in for my interview.
Source URL: https://investorplace.com/2013/06/how-to-avoid-the-pitfalls-of-variable-annuities/
Short URL: http://invstplc.com/1nwlOz9
Copyright ©2017 InvestorPlace Media, LLC. All rights reserved. 700 Indian Springs Drive, Lancaster, PA 17601.