Mom Suggests Clarification on Annuities
“I had some questions after reading your recent column on annuities; maybe your readers are also wondering ... 1. If a financial product can only offer a maximum of 2-3% guaranteed return, wouldn’t it be easier to get a long-term CD at a bank? 2. What happens if the fees are more than the interest earned? Is this possible?” – Mom
Here’s a more in-depth explanation based on my Mom’s questions:
1. In reference to the question, wouldn’t it be easier to get a long-term CD – there are two answers:
“Yes." If the financial product’s maximum return is 3% and you could get 3% from a bank, then you needn’t bother with the alternatives to get the safety and interest earnings you need. When interest rates were much higher, many people simply lived off their CD interest. That’s rarely the case today.
“No,” with some clarification. While today’s annuities don’t typically offer guaranteed earnings of more than 3% or so, that doesn’t mean that they can’t earn much more if the conditions are right. A fixed index annuity (whose interest earnings are tied to a stock market index) could earn 5 to 10% over a year if that stock market performs well (it could also earn zero if the stock market does poorly). A variable annuity, whose earnings are based on the performance of funds directly invested in the stock market, could earn a high rate of return or could lose money.
2. As to the second question, can fees be more than the interest earned:
“Yes,” it is possible. The original principal could be eroded despite the product’s claim of “principal protection.” For example, I recently met with a retired couple who had invested $200,000 in an annuity. The agent told them they would “earn” 14% each year for five years and that they couldn’t lose their money. I reviewed their most recent statement and found that they had made a piddly $72 during the last two years. That 14% was not a guarantee of earnings, but just part of a confusing calculation for determining future income from the annuity. They were also not told about the annual fee of 1.15%, which had eaten away most of the real interest earned.
Here’s the takeaway: Some annuities can protect principal; some do not. Some have no fees; some have high fees. However, none I’ve seen will protect your principal and give you a guaranteed return of 7% or more. If you need help understanding your annuity or determining if an annuity is right for you, call me!