All About Annuities
All About Annuities
What is an annuity?
In this episode, we discuss what an annuity is, the types of annuities, and when you should be buying them.
Here are a few topics we will cover:
- Fixed annuities
- Variable annuities
- Shifting risks
- Other options and alternatives
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Full Transcript:
00;00;06;29 - 00;00;24;00
Garrett & Paul
Hello and welcome to your investment partners with Paul and Garrett, where we talk about all things financial, focusing on helping you plan, keep and grow for a successful future. If you're new to the podcast, welcome. And if you're tuning in again, welcome back and thank you for listening. Hello and welcome to your investment partners with Paul and Garrett.
00;00;24;10 - 00;00;42;10
Garrett & Paul
Today we are talking all about annuities. What are they and where they can be useful. We answer common questions and share a few insights from our experience with many annuities over the years. My name is Garrett Smith and we look forward to having you with us today. Welcome back. Episode ten We made it to double digits. Congratulations. It's a big day for you, Paul.
00;00;42;23 - 00;01;03;02
Garrett & Paul
I'm feeling good about it. Feeling good about it, Garrett. So today we're going to talk about conversation that kind of ebbs and flows depending on the times in season. But is around annuities. What are annuities? Kind of high level pros and cons, things you should look out for when considering annuity as well as a lot of personal experience.
00;01;03;02 - 00;01;31;25
Garrett & Paul
I think for you, Paul, over the years of, you know, being in and out of annuities. Ben You know, I love annuities and I also hate annuities. You know, I have this. It's one of those financial products that just, you know, there's some really, really good ones and there's a lot of really, really, you know, bad ones. And so it's it's an area that is kind of frustrating.
00;01;31;25 - 00;01;59;03
Garrett & Paul
But also we have to kind of pay attention to. So I guess to start with, what is an annuity and an annuity is basically just a savings account with a life insurance company. That's essentially what an annuity is. And they've carved out through lobbying, you know, special tax provisions in the tax code. And so you can you can put money in an annuity with a life insurance company and really the amounts unlimited.
00;01;59;03 - 00;02;25;11
Garrett & Paul
You could put, you know, $50 a month. You can dump 100,000 in there. You can dump, you know, a few million dollars in there if you want to. And it it from that point forward, it grows tax deferred and anytime you get some tax benefits, there's, you know, some strings attached to it. So these are designed to be retirement enhancement type of vehicle.
00;02;25;11 - 00;02;44;09
Garrett & Paul
So if you, you know, put money in when you're 30 years old and you know, you do a big lump sum, you really need to leave it there until you're 59 and a half, kind of like the the you know, the IRA rules a little bit, work a little bit like that. And so they're long term vehicles, tax deferral.
00;02;44;09 - 00;03;09;19
Garrett & Paul
So there's some benefits there. But they you know, the packages come from, you know, from soup to nuts. There's just there's a million of them out there. And no doubt about it. Yeah. I think one thing on annuities is they can be great products, they can solve specific needs. But generally when things are somewhat, you know, unlimited from a tax perspective, you got to be a little more careful with them.
00;03;09;19 - 00;03;38;15
Garrett & Paul
Uncle Sam usually seems to clamp down on the really, really good benefits, you know, like Roth IRA contribution limits. You know, tax free nature is more beneficial than tax deferred. Generally speaking. And so I think any time you enter this world, you've got to pay it, sit up and pay attention to the type of contract you're entering. Well, I think one of the problems that annuities have is, by and large, they're they're sold by, you know, commissioned driven salespeople.
00;03;38;15 - 00;04;06;11
Garrett & Paul
And so, you know, there's there's plenty of abuse there. Some of the tactics are pretty aggressive. Sometimes people are sold annuities when they really shouldn't be buying an annuity because it doesn't really fit. And that's where the that's where my hate relationship with annuities comes in is that, you know, they're great products for the right reason, but they're terrible products for the wrong, you know, if they're used in the wrong situation.
00;04;06;11 - 00;04;34;25
Garrett & Paul
And so you just have to be, you know, kind of really careful about them. You know, there's basically two types, two general types of annuities are fixed annuities and variable annuities. And so a fixed annuity, you know, there's there's no market risk to a fixed annuity. Generally, they pay a specific interest rate. Variable annuities is is basically you're buying a tax deferred mutual fund.
00;04;34;25 - 00;05;01;23
Garrett & Paul
So there's lots of investment opportunities inside a variable annuity. You can kind of pick from pretty aggressive down to pretty conservative and everywhere in between. And and you get kind of market returns and those are the two general type of annuities that are available right now. And between the two, you know, it does kind of allow you to specifically dial up or down the risk that you're wanting to to take from an investment perspective.
00;05;01;23 - 00;05;24;09
Garrett & Paul
Right. And it's, you know, very clearly defined about what types of risks you will be taking, whether it's market risk or or just the insurance company fixed kind of bucket risk. Mm hmm. Yeah. And and and, you know, all these annuities for for the most part, the insurance companies, you know, people need to understand that insurance companies are for profit businesses.
00;05;24;09 - 00;05;55;14
Garrett & Paul
And so generally you can get into an annuity and there's no upfront cost or anything like that to buy an annuity. A lot of the you know, the costs associated with an annuity are invisible. But that doesn't mean there's not costs involved with these products on a fixed annuity. You know, the cost is really just opportunity cost. You know, you you give your money to an insurance company and they guarantee, you know, say, a three or 4% return.
00;05;56;05 - 00;06;14;21
Garrett & Paul
They're working just like a bank. They they take it in, give you your three or 4%, lend it out on the back side and, you know, make you know, quite a bit more than that. And and you're just shifting the risk to the insurance company. They go make a profit just like a bank does by lending the money out.
00;06;15;10 - 00;06;55;15
Garrett & Paul
And then you get a fixed fixed rate of return and variable annuities. Anytime you have an a variable annuity, there's going to be investment expenses depending on, you know, the investments that you choose underneath there. So there are there are costs associated with with these annuities. And one of the things to be careful of is especially if you're working with a salesperson, is, you know, insurance companies traditionally what they'll do is they'll they'll let you purchase the annuity without any cost upfront, but then you're obligated to stay in that particular product for a period of years, traditionally a minimum of five years.
00;06;55;15 - 00;07;27;27
Garrett & Paul
And I've seen actual surrender charges on annuities that go clear out to like 15 years where you, you know, if you withdraw the money prior to 15 years, there's a there's a back end fee that they charge you to pull the money out. And you really need to be wary of anything that goes anywhere near 15 years and the and I think I'll those over the years companies and illustrations have become better at laying out what those penalties are.
00;07;27;27 - 00;07;50;21
Garrett & Paul
You can actually find them in illustrations. You can find them in the layout. And so they are in the documents, you know, they can be found. And I think they've become clear over the years. But one of the problems is, is that when you you know, when you buy an annuity, you get a contract that looks like a life insurance policy contract that probably has, you know, anywhere from you know, probably 25 to, you know, 40 or 50 pages long.
00;07;50;22 - 00;08;10;28
Garrett & Paul
And it's in there sometimes it's kind of hard to dig out. But but it's in there. And and you know, you kind of have to just make sure, you know, what your what you're getting into. And, you know, there's really not any reason to buy a product that you're stuck with in today's world. There's plenty of annuities out there now that, you know, you can put the money in.
00;08;10;28 - 00;08;41;17
Garrett & Paul
And if you decide, you know what, I don't like this, you can within a very short period of time, year or less, you can pull the money out and there's no penalty from the insurance company. And so the I think one of the issues is, is the longer the the longer the surrender penalty and the higher the penalty to withdraw the funds has a direct correlation to the compensation that the salesperson is getting on the on the product.
00;08;41;17 - 00;09;06;07
Garrett & Paul
So if you have a, you know, a 15 year surrender penalty and the first year your penalty to pull out is, you know, 15% or something like that, that that salesperson's probably getting ten, 12, 13% commission on that particular product. And they just there's just no reason for that. Those those kind of annuities need to be avoided at all costs because there's really not any upside.
00;09;06;14 - 00;09;37;13
Garrett & Paul
Why do you want to be stuck with something if you're unhappy with it after a year or two? It just doesn't doesn't make any sense. Now, are all annuity products sold on a commission basis now, you know, up in the last few years and, you know, probably the last 3 to 5 years, insurance companies have realized that there are investment advisors out there that just work off of a flat fee like we do, and they've made products available for people to to use.
00;09;37;13 - 00;10;19;08
Garrett & Paul
And there's no, you know, upfront cost, no cost to pull the money out early. And you know, there's still costs associated with it, but there's not any of these long term surrender costs and penalties and things like that that are associated with the products. And so those are those are a lot more applicable in today's world. And I think, you know, I think any time somebody is going to buy a an annuity product or if you're interested, certainly get a second opinion and even a third opinion particularly get an opinion from somebody who who does not work for commissions, because you'll be able to get a, you know, a good, honest assessment of whether that's
00;10;19;09 - 00;10;47;14
Garrett & Paul
number one. Is that a product that's suitable for your situation, which it very well may be. And if it is, there's probably a product available that you can avoid, you know, five, ten, 15 year surrender penalties on. Yeah, I think that's a great consideration of of getting multiple opinions around an annuity. It is you know it's a specific product they're coming from insurance companies and reviewing their solving the specific needs you're hoping there that you're signing up for them to solve.
00;10;47;21 - 00;11;08;21
Garrett & Paul
But but that's what you know, that really brings up the idea that, you know, that's where annuities fit really well as insurance companies are really good. If you think about just what insurance companies do in general, they are they shift risk, right? I mean, when you when you buy a homeowner's policy, you're you're shifting risk to the insurance company.
00;11;08;21 - 00;20;57;29
Garrett & Paul
So they just take out a whole bunch of premiums in from a lot of, you know, a lot of different homeowners and.
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