Annuities: Love ’em or hate ’em, I am not going to debate that here. But one thing I am going to rail against is having them in Non-IRA accounts.
“Oh no! What’s this guy saying???” I can hear my fellow financial planners utter in pure disbelief.
No Double Tax-Deferral – So What?
“Doesn’t he know you don’t get double tax deferral by having annuities in an IRA???”
My answer to this is simple. What happens when you want to move an annuity that is NOT in an IRA to another account?
THINK about this, folks! You have an annuity that is NOT in an IRA and decide you want to move it someplace else.
What are your options?
Well, let me share with you an example I’ve seen a million times if I’ve seen it once.
$100k to $180k in 15 years!
Guy puts $100k into a Variable Annuity in 2003. Now, it’s 2018 and he looks at his year end statement and sees the annuity has grown to $180k.
Yet, his other account in which he invested $100k into a plain vanilla mutual fund has grown to $375k over the same time, and this is AFTER paying a 3.5% front end commission!
To say the least, he isn’t happy.
Transfer Annuity To Mutual Fund – Huge Tax Consequence
So, he wants to move the annuity to his mutual fund that has more than doubled the annuity performance.
Unless he is willing to pay taxes on that $80k this year, he can not move the annuity to the mutual fund.
The only way to move an annuity to any type of non-annuity account is to pay tax on whatever gain he has…ordinary income tax too mind you. Not capital gains!
While the growth on the annuity doesn’t seem like much compared to what he receive in the plain vanilla mutual fund account it’s still sizeable enough that if he cashes it out, he will probably lose $20k in taxes in not more.
3.18% After Tax Return…After 15 Years!
Thus after tax the annuity only gave him a $60k or so gain, after 15 years! We’re talking a 3.2% rate of return… that’s nothing to write home about.
Now he can do what’s called a 1035 exchange into another annuity. That allows the gains to continue to be deferred. But the problem with 1035 exchanges is you can only move your annuity into another annuity. That’s it.
You can’t 1035 exchange into a mutual fund, a cd at the bank, your checking account, anything. Only annuity to annuity in order to keep the tax deferral.
Now, before we go any deeper we need to examine WHY the annuity underperformed as much as it did.
Thankfully the answer is quite simple: FEES!
Fees on top of Fees
Annuities have fees on top of fees.
I typed in “Variable Annuity Prospectus” in Google and the first answer that came up was the Transamerica annuity I examine in the video.
This charges Mortality and Expense fee of 1.00% or 1.35% depending on the bells and whistles you choose.
What the heck is the Annual Fund Facilitation Fee???
They also have a .30% for something I can’t even explain. Plus the funds they use are going to have fees, typically around .90% to 1.1.0% or so.
Plus there is usually an annual account fee and who knows what else.
All these fees do in the aggregate is limit your growth.
If the market gives you a GROSS 7% and you’re paying 3% a year fees, you’re only going to net 4% a year. There really is no other way to look at it. Yes, the annuity provides a benefit that the mutual fund account does not.
But I examine
A. the cost of that benefit
B. the likelihood you’ll end up using it.
Fees Hurt Growth
No matter how you slice it, the annuity is loaded up with fees, which hurt growth. And when it comes time that you want to move the annuity, the limited growth it did provide will still be a thorn in your side, because if you do move the annuity, you will pay tax.
Distributions Taxed As Ordinary Income
All at once. All at Ordinary Income rates.
Which is why if you are going to have an annuity, it should be held IN AN IRA! Because if it’s in an IRA you can move it to ANY type of investment that your IRA provider allows you to hold, without an immediate tax.