Beware of Brokers Bearing Annuities

The first baby boomers are making plans for retirement, with their 401(k) plans stuffed with savings. In response to the pending onslaught of soon-to-be retirees, the insurance industry has metamorphosed into "retirement planning." However, it's promoting marketing techniques designed more to generate sales than to expand investors' holdings.

Companies offering variable annuities, including Hartford (NYSE: HIG  ) and the John Hancock division of Manulife (NYSE: MFC  ) , often add extra features, also known as riders. Agents like these provisions, since they sound good and help win over risk-averse customers. But they often prove completely unnecessary, adding nothing to the value of the annuity or its eventual payout.

For instance, one type of rider is called a guaranteed minimum accumulation benefit (GMAB). It promises that the value of a variable annuity will rise by at least a certain percentage -- often 6% -- over time. Sounds nice, doesn't it? But there's a catch.

The troubles with GMAB
For beginners, the fees to add a GMAB can be obscenely expensive. If you add mortality and expense charges, administrative costs of the variable annuity, and the extra GMAB fee, you could easily pay expenses topping 3% each year.

That wouldn't be so bad if you actually got something from it. But the odds are good that you'll never need such a benefit. Some annuities tied to the stock market use a long timeframe -- such as 10 years -- to apply the GMAB. That means that in order to get a benefit from the GMAB, the market would have to earn less than 6% annually over a 10-year period. Historically, the last time that happened was 1984 -- a period that included the tail end of the 1973-74 bear market. The GMAB feature isn't likely to cost the insurance companies anything close to what they'll make on it.

Pensions and annuities
Another marketing ploy annuity salespeople trot out is the benefit of annuitizing 401(k) rollovers. They argue that the rollover will be taxed as ordinary income, so why not buy an annuity with it? That line of reasoning is true. Yet often, the annuities they recommend -- especially equity-indexed and variable annuities -- are unsuitable investments for retirees.

Retirees who want to replace a salary or create a pension-like cash stream should consider an immediate fixed annuity. Although it often won't pay a death benefit to your heirs, it will usually offer higher payouts during your lifetime. Check out low-cost providers such as Vanguard or Integrity Life for options on immediate annuities. In addition, if you want a beneficiary to get back at least what you paid for the annuity, you can choose a return-of-premium benefit.

Zealous annuity marketers will sometimes misrepresent an annuity's fees and commissions. (I've heard them do so myself.) Don't fall for it! Except in rare cases, the higher costs for annuities simply mean that you're giving more of your hard-earned money to your broker. Most of the time, comparable mutual funds in a rollover IRA make much better investments.

Have questions about retirement? Try Motley Fool Rule Your Retirement free for 30 days. With no obligation, you've got nothing to lose and everything to gain.

Fool contributor Buz Livingston, CFP owns none of the stocks listed and appreciates your feedback. He believes investors will benefit from professional advice. The Fool's disclosure policy is always on your side.

Read/Post Comments (3) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 10, 2010, at 6:31 PM, Nanance wrote:

    Does anyone have an update on how guranteed fixed index annuities should be viewed since the "crash" of 08 and recession? This article is pre-crash and I'd like insight on these products in today's volatile market.


  • Report this Comment On October 01, 2010, at 6:27 PM, buzman wrote:

    I wrote this column.

    Fixed index annuities are the same garbage as equity indexed annuities.

    They have huge surrender periods/high costs and that boom in 2009 where the S&P was up 25+%, equity income annuities were limited to 8-10%.

    Real money is not guaranteed. The guarantee is limited to an accumlation account and the only way you get that is to annuitze the balance.

  • Report this Comment On May 19, 2011, at 5:19 PM, smartbunney wrote:

    Thanks Buzman, but I don't understand your last sentence "The guarantee is limited to an accumlation account and the only way you get that is to annuitze the balance"

    What does this mean?

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