Pitfalls Made by Annuity Shoppers
As with any investment vehicle, annuities can be confusing if they are not researched properly. There are some common mistakes – or annuity pitfalls – that investors often make when purchasing annuities. Each type of annuity – fixed, variable, and index – has its own unique pitfalls which need to be taken into consideration.
Variable Annuity Pitfalls
1. Diversification is important to balance out the downturns in any one investment. Advice varies on diversification levels, but general annuity investments should be divided by between 3-5 subaccounts at a minimum.
2. Many investors do not realize that early withdrawal fees may apply to annuities. Therefore, they do not always consider if they will need the cash they are preparing to invest in a variable annuity if their circumstances or the market conditions change. To avoid this unfortunate situation, do not investment money that you may need during the contract period of the annuity.
3. In addition to the withdrawal fees, management fees should be understood. Often variable annuities charge 1 to 2% account fees which is similar to those levied by mutual funds.
4. Variable annuities offered by different companies have different options. Make sure the option you are interested in is actually available in the annuity’s prospectus before you start the investment paperwork.
5. Some variable annuities charge commission fees, like mutual funds. Look for “No-load” plans to avoid this charge.
Index Annuity Pitfalls
1. Similar to variable annuities, withdrawal fees may apply to index annuities. The same advice applies. Do not invest money that you may need during the contract period of the annuity.
2. Many investors do not realize that an index annuity can have a maximum annual yield cap as well as a minimum floor. Look for annuities with high caps or that are classified as “No-cap.”
3. Only invest in index annuities that zero out every year. This option is called an annual reset provision. By selecting this option, the account balance cannot drop below its previous high.
4. Similar to variable annuities, some index annuities charge 1 to 2% account maintenance fees. Make sure it is understood what the charges are, and make sure that they are fixed.
5. Understand how the annuity calculates growth to avoid surprises at valuations or distribution.
Fixed Annuity Pitfalls
1. Similar to variable and index annuities, withdrawal fees may apply to fixed annuities. This is probably the most important advice an annuity investor can take away which is why it is has been repeated again in each section. Do not invest money that you may need during the contract period of the annuity.
2. Guaranteed rates do not always stay constant for the full term of the contract. Some annuities are advertised with a high rate, but it may only be valid for the first two years of a five year annuity, for example. It is, therefore important to understand the guaranteed rate structure of a fixed annuity before it is purchased.
Overall annuities are solid retirement savings instruments, but they need to be studied properly to avoid common pitfalls and future disappointments.