Early Retirement - Financial Freedom (Investing, Tax Planning, Retirement Strategy, Personal Finance)

5 Reasons You Should Not Buy An Annuity (And When To Surrender One You Have)

• Ari Taublieb, CFP®, MBA • Episode 209

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Ever wondered if annuities are worth the hype? Let me share a cautionary tale that might change your perspective. My parents found themselves trapped in a conservative annuity with high fees, resulting in significant opportunity costs. We'll uncover the five critical reasons to steer clear of these financial products, from limited growth potential to inflexible terms, and explore the impact of surrendering an annuity on your tax situation. Whether you're contemplating an annuity or already own one, this episode equips you with the knowledge to make smarter financial decisions.

Balancing financial logic with personal comfort, we dive into real-life examples that challenge conventional wisdom. Imagine recommending 100% equities to an 83-year-old client because of their diverse income sources and financial security. We’ll discuss why sometimes peace of mind can outweigh potential returns and debate the merits of paying off a mortgage versus investing. Learn when it makes sense to hire a financial advisor and how to align your financial strategies with your unique circumstances and goals. Tune in for insights tailored for both novice and seasoned financial planners looking for a personalized approach to managing wealth.

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Ari Taublieb, CFP ®, MBA is the Vice President of Root Financial Partners and a Fiduciary Financial Planner specializing in helping clients retire early with confidence.

Speaker 1:

I do not like annuities, and I will be very transparent about that Now. There is a role for them in a retirement plan that I will discuss. But one of the advisors that my parents worked with at one point had recommended an annuity, and the problem with the annuity was, for my parents, it was way too conservative, the fees were way too high and it ended up resulting in significant opportunity cost Meaning. If they had just instead invested their money into a brokerage account, which I call a superhero account, they would have much more money today. So I'm going to explain the five reasons to not purchase an annuity and, if you do have one, how to think about whether it makes sense to surrender it. Sometimes, my feedback is you know what? It actually makes sense to keep it at this point. Sometimes it's nope, certainly still makes sense to surrender it, but we got to be careful because there could be tax implications. So this is just going to be your complete guide to thinking through annuities. If you don't have an annuity and you just want to hear an analysis about it, be my guest and listen to this If you're like look, I don't have any interest in annuities. I already don't like them and I don't want to hear more about them. Make sure to check out one of the other episodes, because this might not be the one for you. I am a podcast listener in addition to a podcast host, and I appreciate when other guests tell me hey, this might not be applicable to you, check something else out, or nope, this could be right, in alignment with what you're looking for. So I want to help as many people as possible, which is why I have a wide variety of content.

Speaker 1:

Now I'm going to start with a review of the week. Now, this review was right after I released my special episode where I announced that I was at episode 200. So thank you so much for reviewing, letting people know your thoughts on the show. If you have not done it already and I've helped in any way, please do leave a review Either. If you're watching on YouTube, drop a comment, and if you are currently on the podcast app, you can leave a review on Apple, but Spotify does not let you.

Speaker 1:

So this comes from Compact8, who says Thank you, ari. Great broadcast. I'm probably more advanced in financial planning for myself than the average person. Lots of great advice, I believe. James, who is my partner if you're unfamiliar, and Ari have a great business and great values. I think in today's world it is hard to find people that focus on their clients more than their personal gain. Ari has much good information for all, from young people getting started to people very close to retirement. Thanks again for the podcast I listen weekly. You're very welcome. Thank you for the review and I want to hop right in.

Speaker 1:

So what on earth is an annuity? Well, an annuity is someone who's generally a salesperson, less of a financial advisor, and what they're doing is they're saying hey John, hey Jane. I know markets go up and down like crazy, so, trust me, how would you feel if a 2008 happened and you knew your money didn't go down? And they'd be like that sounds great, because that was my parents. Now, what that salesperson is refusing to often be transparent about is how much that is paying them, which I will talk about, and the lost returns in the years where markets do really well. Generally, an annuity might have a cap, which means if markets do 20%, it might only allow you to capture 5%, but on the downside, it will sound really good because it's like well, what if markets go down 30%? I'm only down 5%, so it's almost protecting me in that way.

Speaker 1:

The issue with annuities are multiple, but I'm going to start with just here are the five reasons and then I'll go through each for you and what to consider. So if you are considering to purchase an annuity, I'd want you to think about this. Number one the opportunity cost generally with an annuity is not just the fees and is not just how it works. It's the fact that it limits your growth and by you limiting your growth and not capturing when markets do really well, you lose out on significant returns, and I'll show you an example. So that's number one is you can get higher returns elsewhere. Number two is flexibility. With an annuity that is going to guarantee income, it doesn't always have a cost of living adjustment. So if you're guaranteed $5,000 a month, in 20 years, when you're relying on that for income, the $5,000 a month might be worth $3,200 a month. So it's not keeping up with the cost of inflation. So number two is flexibility, because not only is it not growing with the cost of inflation, it's also not accessible to you.

Speaker 1:

Meaning, let's assume you pass away, and I'm just going to use an example. Let's assume you are 65 and the annuity gets turned on and at 67, you pass away. Well, that doesn't go to your heirs. It might go to a spouse if you have a certain type of annuity that will leave dollars to them. Generally it's not at the same amount, but more often than not you pass away and that just goes away, and that is something you may have paid a lot of money into for many years and you want that to be part of your legacy, and now that doesn't get to be so. It can be a really crappy return if you put a ton of money into this and now all of a sudden you're 67 or 75 or 80, you pass away and that's money $300,000, $400,000, $500,000 that could have gone to a spouse or a partner or a child. So number two is flexibility, where I want you to be able to tap into those funds if you so choose. What if it turns out a significant health event occurs or you want to help out a kid with a wedding? You can't just go. I want more money. There's a schedule that you're being paid out on, so I don't like the lack of flexibility.

Speaker 1:

Number three is the fees. Most diversified portfolios have a fee generally, let's call it 0.2 to 1%. I've seen everything up to 4%, but generally 0.2 to 1%. So if you're thinking about what that actually means, think of Vanguard. Vanguard is a company with very low fees. Meaning if you have a Vanguard product, the fee is something like 0.05% extremely low as a whole could be 0.01%. So you could be paying potentially a few hundred bucks a year on a million dollar portfolio.

Speaker 1:

Now, with an annuity, generally I see the all in fees in the range of 2% or so. So if you have a million dollars in an annuity, well, you're spending $20,000 a year just in the fees. That's before the lost market growth, and you don't have any flexibility. So the fees on annuities are significant, which is my big issue. When you see an annuity that has, let's say, 4.5% growth, but with 2% fees and not adjusted for inflation, well now you're just losing money on this product.

Speaker 1:

But the fourth reason to consider not purchasing an annuity is the commission that goes to the actual advisor that sold it to you. So that is the ultimate question you want to ask. I'm not against people feeding their family and making a living, but I'm against it being unethical and this bridges on that a little bit for me when someone is recommending an annuity for 500,000 bucks if there's a 5% commission on that, well, that's significant. If there's a 10% commission on that, well that's very significant. So I want to make sure that you're not right off the top, losing $5,000, $10,000, $15,000, $25,000, where it would just take you years probably three to five just to get back to break even because of the cost that went to the advisor right away.

Speaker 1:

The last reason is annuities get in the way of tax planning. If you turn on social security and you have an annuity and you have an IRA that you're withdrawing income from and there's a pension or rental income or any combination of anything I just said, that is going to interrupt tax strategy because now you have income coming in, whether you want to or not. That impacts healthcare subsidies, that impacts required distributions. That impacts your ability to likely save tens, if not hundreds, of thousands of dollars in taxes. So those are the five reasons that I'm not a big fan of annuities.

Speaker 1:

But let me give you an example. So I wrote this out. This was from a client. I tweaked the numbers a little bit, but let's assume, excuse me, my editor does a good job but, as you all can probably tell, I'm a little sick today. I will always make podcasts every single week and sometimes I don't feel the best and I know it's probably not fun to hear on the audio, if you hear me make that little noise out of my chest, so apologies for that, and I'm in the midst of a few different things on that end. So more updates to come on that later, definitely feeling better, but wanna make sure you're getting authentic content. My editor is amazing and will do a good job to make sure that those noises that aren't always fun to hear are minimized. But I care that you get the content. So thank you for the delays in between today's little blips of content.

Speaker 1:

So this is assuming John is 55 and he buys an annuity and let's just assume he bought it I don't know 10 years ago. So he bought it when he's 45 and he's 55 today and he put a hundred thousand in. Well, there's a few different figures. The first figure we want to understand is the surrender charge, meaning what would it cost if you wanted to leave that? Let's assume it's 5%. So now you're going. Okay, if I wanted to leave, I've got. I put a hundred thousand in. Now let's hope it's got value. Call it surrender value of 150,000. You have to pay 5% to leave. Now, generally surrender values have a schedule. So if you were to leave after one year, the surrender charge might be 10%. If you're to leave after two years it might be 8%. If you're to leave after three years it might be 6%. That decreases over time. They're incentivizing you to hold on to that annuity. Now let's assume for John this would guarantee a payout of 12,000 bucks a year for the rest of his life, from 65 to 95.

Speaker 1:

John likely purchased this because he was scared by markets fluctuating in retirement he wanted to diversify. So he's like, hey, I've got some maybe real estate, I've got some investment stuff, maybe I add on an annuity to that. So that may have been his thinking in this example and this is a client I have. So let's assume he surrenders this $150,000. He takes a 5% surrender charge. That's a $7,500 hit right off the bat. So now he's left with 142,500. Now, if you're listening to the podcast, I know numbers can be a lot and oftentimes you guys are listening to this while you are working out Soudos to you. Now I'm going to keep going along with the numbers, but I'll try my best on youtube to make this more of a visual so it's easier to follow along.

Speaker 1:

Now let's assume that annuity continues to grow and we don't surrender it. Well, generally that fee is likely in the range of two percent. So two percent is $3,000 a year off $150,000. And that fees over 10 years would be $30,000, just the annuity product and assuming 4% growth, which is very realistic for an annuity. After fees the $150,000 is likely worth $170,409. That's just me doing basic annuity projections.

Speaker 1:

So what if he instead said you know what, maybe I do surrender this thing. It doesn't feel good right away. Now you've got $142,500. And let's assume you get 7% growth. Reality is you could do 6%, you could do 8%. I'm just picking 7% for conversation's sake. After 10 years you would have $280,147. So you would have north of $100,000 more because you're not paying as much in fees and you're decreasing the. You're actually increasing the growth but you're decreasing the internal fees and the lack of growth.

Speaker 1:

So, comparing it, if we were to take a 4% withdrawal rate, once again, not a huge fan of the 4% rule because it doesn't apply to an early retirement, it's designed for 30 years and it doesn't assume you're intentional and spend more when markets do well and spend less when markets don't do well, but just for conversation, let's assume 4% per year, you would turn on income of about $11,206. So some of you are like, hey, at the beginning didn't you say the annuity would pay out $12,000 a year, and now you just said it'll pay out $11,200. So why would I do this? Well, that $280,000, you can take out more. If you would like, you can take out less. It's a flexible thing, you can move it. As opposed to in your annuity it's $12,000 a year every single year. So in three, four years that $280,000 continues to grow. Well, now, you can take out more than $12,000 a year. So in the first one, two, three years maybe it's a little bit less, but the next 25, 30 years it's hopefully a whole lot more. So, generally, annuities I will only recommend Actually, I've never recommended them, but I've had a client actually keep it and I told them I agree with that because they were a widow, they were never educated on finances, markets freaked them out as a whole despite a vast amount of education.

Speaker 1:

And they're like Ari, I know what you're saying. I know I could do better. I just sleep better having this annuity and I was okay with it because they had a pension and rental income and significant inheritance. So they were going to have way less money by having this annuity. They did not need it. I told them that they said I get it, ari, but I just sleep better at night having it. And I said, cool, because there's a financial answer to this. And then there's the hey, what's going to allow me to sleep better at night?

Speaker 1:

The example I like to give here is I have a client who's 83 and they have 100% in equities and I recommended that and some people are like what are you crazy? You know they're 83. Why would you say that? I said it's horrible. And they're like well, why'd you just say it then? And I said it's horrible for their neighbor that doesn't have a pension and social security and rental income, inheritance and wants to spend, you know, 20,000 a month in retirement.

Speaker 1:

You have all of these other income sources. So if, god forbid, your 3 million went to zero, you wouldn't like me. I get that, but you would be okay. So you have the ability to take on more risk because your income would allow for that. You'd still be able to meet your needs and your financial goals. So that portfolio, it can fluctuate more and you can make you way more money, but if you would lose sleep over it going 40% declines at any point, then I wouldn't recommend doing that. Now they understood that and said, hey, I want to grow this like crazy because I have big legacy goals. Other people would say, yeah, I get that I could take this, but do I need that to meet my goals? And I'll be like absolutely not. And they're like well, then maybe I don't do this.

Speaker 1:

So think about it almost like paying off a mortgage versus investing. When you pay off the mortgage and you no longer have debt, it just feels good. Let's be honest. It feels good you don't have any more debt. And so now you're like look, I can't quantify this, I just feel better versus what you quote. Unquote should do is probably, if you have a 4% interest rate, you should probably pay the minimum and invest the rest, because you can probably do better than 4% and make way more money and you're getting a deduction for mortgage interest and there's probably tax benefits and investment benefits by continuing to pay the minimum and invest. But no one throws a party when their investments go up by $100,000. They celebrate when they go I don't have a mortgage, I'm sleeping better, it's one less expense in retirement.

Speaker 1:

So when it comes to planning, there's a financial answer and there's a real life answer. If you're unfamiliar with my academy, you can go in and run those same projections. So if you want to see your annuity versus paying off the mortgage early, versus investing differently, you can start to put the financial answers together and then connect it to the real life answers. Now you can do that by becoming your own advisor or, of course, you know, not for a living, but through the software and learning in that or you can hire an advisor and do one-on-one planning with them. So I have different options. No matter where you're at in your stage of life, if you're early on in your career and you're like early on could even be 10 years in, so it doesn't really sound like early on.

Speaker 1:

But let's let me use a better example, because that wasn't clear. Let's assume you are 50 and you have $2 million in a 401k. Some advisors would say hey, you know you should work with us. I don't think you should work with them because although you have $2 million and you want to invest, well, if that's in your 401k, an advisor could bill you on it, but they're not really able to manage the fund. So it seems unethical for me. Now. Other advisors don't like when I say that and I get it because they send me these messages after these episodes, but that's just how I feel and I'm going to give it to you straight.

Speaker 1:

There's other times where it makes sense to hire an advisor, but it's when they actually have the ability to manage funds and execute tax and withdrawal and the real strategies that add value. So generally I recommend hiring an advisor when you're one to three years out from retirement or have a significant concentrated position or RSUs or stock options or just a lot of complexity where it makes sense to hire an advisor. If not, oftentimes my academy and the software can be sufficient until you feel yep want more help. So there's a ton of different options. You can see in the description of this episode different ways we help people optimize their strategy. Hopefully this was helpful on annuities and just thinking through them in a little bit more detail. That's it for this episode. See you guys next time.

Speaker 1:

Thank you for listening to another episode of the Early Retirement Show. If you have a question that you want answered in a future episode, you can always go to my website, earlyretirementpodcastcom. That's earlyretirementpodcastcom and you can go ahead and submit a question that I'll look to answer in a future episode. Thank you all for listening. Please do rate it, review it and share it with someone who you think would benefit from this information. If there's anyone out there that you know, I certainly appreciate it and I will see you all each week. Hey guys, it's me again. Please be smart about this. Nothing in this podcast should be construed as financial, tax or legal advice. Consult with your tax preparer or financial advisor before taking any action. This podcast is for informational purposes only.