Six Critical Questions to Ask BEFORE You Buy an Annuity

Steve McDonald By Steve McDonald, Bond Strategist, The Oxford Club

Retirement Planning

Here’s another tale from the retirement belt about record-high market jitters and how they can cost you a lot of money…

Dan has been hanging wallpaper for 30 years, and he’s the best. Not the cheapest by a far stretch, but his work is as close to perfect as it gets.

And he’s also the exception to the rule for his generation; he has saved and invested wisely.

He was working in our home recently and heard me on the phone talking about bonds and the market. He told me it was funny he was in my house on that particular day. When he finished, he was going directly to his bank to sign the papers to finalize a deal for an annuity.

My stomach immediately went into a knot.

“Did you sign anything yet?” I asked.


“Thank God,” I said.

Don’t get me wrong, annuities have their place. But in most cases, you can find services with much lower expenses than insurance products carry.

The trouble is that most folks don’t know the right questions to ask to find out what the fees are.

In this case, the person selling Dan this annuity didn’t bother to elaborate on the costs or real benefits, not the possible benefits.

From previous conversations, I knew that Dan has held several good stock funds for almost 20 years. So I asked him why he wanted an annuity.

Was he unhappy with his returns?

On the contrary, he said he had done exceptionally well in the markets. He has a 10-year average return of 13%.

“That’s excellent!” I said.

Based on those numbers, I asked why he was shifting gears now. His answer says it all…

“I want something that won’t lose any money. The market is so high and has been going straight up for so long, I’m afraid of a big loss.”

The record-high jitters overwhelmed his excellent market experience – and reason.

After 27 years of talking to average Joes about their money, I know better than to take on the fear of market highs and volatility. It’s a losing battle.

So I shifted gears and approached it from the cost/return angle. I asked some basic questions about annuities that all people should ask before they sign on the dotted line.

What’s the upfront payout to the broker?

Annuities are famous for big payouts to advisors – 4% to 6% is not unusual. And no matter what any salesman says, it comes right out of your pocket. No, you don’t see it, but trust me… they aren’t charging some other client’s account for the fees.

Dan didn’t have a clue. No one ever does.

How about the annual fee? How much is it, and can it fluctuate between a minimum and a maximum?

Again, Dan did not ask. No one ever asks about this. The insurance business is excellent at avoiding any discussion of cost – annual or otherwise.

If you change your mind or need to cash out, what’s the rear-end penalty for taking your money out?

Most annuities have a declining rear-end charge if you need the cash. I have seen some go out as far as eight years. And the cost per year is anywhere from as high as 8% in the first year, declining annually over four to eight years to zero.

Remember, you’re being charged a fee to get to your money.

What kind of guarantee do they offer?

Dan said, “2.75% a year.”

“Let me see the document.”

That guarantee is good for only one year, and then it can pay him as little as 0% after that.

“Yes,” he said. “But I can make as much as 6%, and I can’t make less than 0%.”

But the only guarantee was not making less than zero. He’s paying a lot of money in fees for a guarantee of 0% return.

How do they calculate when you are paid the maximum allowable return of 6%?

He had no idea. I’ve never heard a good, understandable explanation for that one.

Then the coup de grâce… It has nothing to do with expenses, but I had a feeling it would be a lulu of an answer…

I wasn’t disappointed.

How much are you putting into this contract? What percentage of your money?

“Forty percent of everything.”

This is when I stopped being a nice, professional guy who wanted to help.

“Are you f*****g crazy?”

That’s not one of the questions you should ask, but it fit the occasion.

Forty percent in anything is too much. In an annuity that guarantees only that it won’t pay less than zero, it’s insane. He could be looking at years of nothing but fees.

But I was losing the battle.

His fear of market volatility was so great – despite all the reasons I gave him to consider other options – he still felt he had to go for the guarantee of nothing less than a 0% return.

And, keep in mind, Dan has 20 years of market experience under his belt. He’s no newbie. Newbies are flocking to guarantees of nothing more than an annual loss after taxes and inflation.

That’s how strong the record-high jitters can be and are in this market.

So I printed out the same questions for him I listed here and told him to ask his advisor to address all of them before he signed anything. I also told him not to expect any direct answers.

A guarantee of not less than zero is no guarantee at all. And if you have to pay a hefty rear-end charge to get your money, it doesn’t compute.

If you can commit to four, six or eight years on an annuity contract (that’s how long you could have to wait to get all your money out without a fee), in all likelihood, you can make a lot more in stocks and bonds… at a fraction of the cost.

Since he was insistent on a guarantee and was willing to accept 2.75%, my last bit of advice was to look at CDs at EverBank online.

Normally, because of the after-tax and after-inflation numbers, I would never go the CD route. But as it turned out in this case, the rates for five years were above the minimum he was guaranteed for the first year.

And at least he’d be earning something every year with a real FDIC guarantee.

But more important than the return or the FDIC insurance, while CDs do carry an early withdrawal penalty, there are no front-end or annual fees! And you know about the penalty upfront.

The less market experience you have, the greater the damage from record-high market jitters can be. Make sure you know all the facts about guaranteed investments.

Good investing,