I recently saw an ad on national television with a financial advisor looking straight into the camera and saying he would never sell an annuity to a client. He then proceeded to list off numerous reasons why he would never let a client consider an annuity, saying things like annuities are “confusing” and could subject a client to tax problems.
These misconceptions about annuities are rife among prospective clients. Many clients have these perceptions because of ads they’ve seen that make annuities sound like unsafe financial ventures offered only by predatory salespeople. This is ironic because annuities are designed to reduce risk. Other clients who are less familiar with annuities simply may believe their hard-earned dollars are better invested with their bank or the stock market.
Regardless of how clients have obtained inaccurate perceptions of annuities, it’s our job, as agents and financial advisors, to correct them. That’s because annuities can be an important tool to help with a client’s overall financial portfolio, as they offer advantages that include reducing risk and providing a more predictable future. Annuities offer flexible payout options with guaranteed income streams if desired, and earnings aren’t taxed until the funds are used. This is especially appealing for clients interested in using a fixed annuity as a tool to secure income for the future, generally during retirement.
Here are a few common misconceptions about annuities that you may hear from clients, as well as some tips on how to clear up those misconceptions.
Misconception No. 1: Annuities are confusing
Although the idea of an annuity may be new to your clients, annuities have been around for decades with the same straightforward structure. Any annuity — whether it’s fixed, indexed or variable — is built to provide earnings potential as well as some measure of safety to a client. If your clients aren’t interested in guarantees of safety, then an annuity likely doesn’t fit their preferences. But in my experience, most clients consider safety to be a very important factor for at least a portion of their savings.
To protect the financial integrity of the insurance carrier that is providing the safety, annuities require a time commitment. By time commitment, I mean that there would be surrender charge penalties for accessing money ahead of the scheduled time. Since annuities are available with a variety of surrender charge periods, your client should understand that liquidity isn’t free. Typically, the longer the time commitment your client is willing to make, the greater earnings potential the annuity carrier can provide. Thus, it’s important to tailor the choice of timing for an annuity based on a client’s goals and needs.
Misconception No. 2: Annuities don’t do what a client would like them to do
Overcoming this misconception requires you to set expectations with clients about the merits of the different types of annuities, and how an annuity can protect their hard-earned dollars.
Consider highlighting these types of annuities and the nuances of each:
• Fixed annuities have a declared interest rate, and some have an interest rate that is fully guaranteed for the entire surrender charge period — similar to a bank certificate of deposit.
• Indexed annuities provide interest credits based on a market index. They provide a portion of the index’s increase as interest credits for the client. There is usually a minimum and maximum interest credit, where the minimum provides protection against the index’s decrease.
• Variable annuities have subaccounts much like mutual funds. They provide protection against loss via their death benefit feature, plus they often provide further guarantees through a guaranteed lifetime income rider.
Misconception No. 3: Annuities come with high fees
This misconception is often the result of an annuity that isn’t purchased in line with a client’s needs or financial goals, which are important points for an advisor to know before an annuity is purchased. With a fixed or indexed annuity, a client typically would only pay a fee in the form of a surrender charge, which is avoidable as long as the client abides by the time commitment. Or a client would pay a form of a fee associated with an optional rider that provides an additional guarantee, such as a guaranteed lifetime income rider.
For a variable annuity, a client could run into three different types of fees: one for investment management, another for the insurance company’s expenses and a third for the guaranteed lifetime income rider. Because of these fees, it’s important for you to make sure a client believes the amount of safety provided by a variable annuity is worth the fees.
On fixed or indexed annuities, critics sometimes will say that there are “hidden” fees. That’s because the carrier considers its expenses in setting the interest rates on its annuities. But this is no different than what customers experience with financial products they buy from banks, such as CDs or savings accounts.
Misconception No. 4: Annuities can cause tax problems
An annuity isn’t taxed until a client makes a withdrawal or starts taking regular distributions. If a client has money in a corporate retirement plan — such as a 401(k), 403(b) or 457(b) plan — or in an existing individual retirement account, those funds can be transferred into an annuity tax-free.
What’s more, as an annuity earns interest, that interest can stay in the annuity tax-free. However, as with all non-Roth IRAs and corporate retirement plans, when your client ultimately takes withdrawals, the withdrawals will be taxed as ordinary income. In a Roth IRA annuity, as long as your client keeps the money in the annuity for at least five years before taking a withdrawal and doesn’t take any withdrawals before age 59½, the withdrawals and interest credits can be completely tax-free.
For regular savings — or, in other words, nonqualified money — annuities offer tax deferral. The advantage of tax deferral is that your clients can control when they are taxed by controlling when they take withdrawals. Unlike direct stock investments, however, annuities do not qualify for capital gains tax treatment.
Educating clients about the timing and fee structure of annuities is important to help overcome the common misconceptions many have about their merit as a financial tool. By doing so, you can help make sure your clients are meeting their financial goals and position yourself as a trusted advisor.
Chris Conklin is vice president of individual annuities at The Standard. Chris may be contacted at firstname.lastname@example.org.