In this week’s episode we answer some Frequently Asked Questions:
Fees & Costs of Annuities:
Think annuities are high cost? Compare them to mutual funds which is how most people invest and which make up almost half of all IRA / 401k assets. Here are the facts:
- The insurance companies don’t charge fees. They align their interests with yours and get paid from the investments they make with your money, just like you. Optional riders like guaranteed lifetime income cost about 0.95% a year. That’s it!
- Mutual funds have fees and trading costs you won’t find in your statement. Average fees are 1.4% a year (Investment Companies Institute) and the same again for trading costs (Institute of Certified Financial Analysts). You have to hold your retirement in 401k, IRA or variable annuity accounts. They charge too. Average 401k fees are 1.1% a year (Brightscope) and variable annuities charge 1.6% (Pacific Life). (Important note – we DO NOT like variable annuities!) Now the math: that’s 3.9%-4.4% coming out of your retirement every single year, even when you lose money. On a $50,000 investment that’s $23,300 in fees and charges over 10 years and $57,468 over 20 years. Bet you didn’t know that!
Think annuities will lock your money up and you’re better off with mutual funds? Here are the facts on that one.
- Hybrid annuities will give your money back anytime. 10% a year is penalty free and you pay a surrender charges on any excess. Charges usually start about 10% or 12% and drop over time. E.g., after 4 or 5 years the charge is down to 5% and after 10 years it’s gone altogether.
- Class A mutual funds charge 5-5.75% up front and only 95% of your money ends up working for you. Class C funds charge when you sell even if you didn’t make money; in a good market you pay the charge on your profits. Now the math: mutual funds can cost almost 9% (management fee + trading cost + sales charge). The charges are forever, not like a surrender charge; they don’t disappear and you pay whether or not you take the money back. Bet you didn’t know that!
How can insurance companies pay good returns when interest rates are so low?
They are far less dependent on interest rates than they used to be. Study a balance sheet and you see a range of assets. Mortgage, infrastructure and energy bonds, student and military housing projects and hedge funds all pay high returns to obtain long term funds and the insurance companies share this “illiquidity premium” with you.* They also trade their own money sometimes in the same indexes you have in your annuity and are now taking over money management for large pension plans. Insurance companies have a reputation as the world’s best risk managers and enjoy some of the highest ratings in the finance industry as a result.
* That’s why they have a surrender charge; when you take your money back they have to replace it and that’s expensive.