What are the Basic Criticisms of Annuities?DeferredDeferred annuities are generally sold by financial professionals, some of whom may work directly for an insurance company. Most financial …
What are the Basic Criticisms of Annuities?
Deferred annuities are generally sold by financial professionals, some of whom may work directly for an insurance company. Most financial professionals, however, are independent agents of the insurance company, not employees. The financial professional who sells an annuity collects a commission from the insurance company. This commission will be a percentage of the total premium paid by the investor. This percentage can be as little as 1% and as high as 12%; the average is 6%. Since these commissions appear high and there are deferred sales charges on annuities, many financial gurus have criticized annuity products.
The investor will, generally, not pay any of this commission directly to the financial professional. The commission is paid by the insurance company to the financial professional up front. The insurance company will recapture the commission paid to the financial professional through the fees charged to the customer (in a variable annuity) or the spread in the interest rate market (for a fixed annuity). There are also deferred back-end charges that will be applied if the investor closes out his or her contract before the agreed upon timeframe, usually eight years. These charges can last for as little as one year or as many as 20 years, depending on the type of annuity and issuing company. These back-end charges concern many financial professionals and financial gurus.
Some annuities do not have any deferred surrender charges and do not pay the financial professional or commission although the financial professional may charge a fee for his or her advice. These contracts are called “no-load” variable annuity products and are usually available from a fee based financial planner or directly from a “no-load” mutual fund company. Of course, various charges are still imposed on these contracts, but they are less than those sold by the commissioned brokers. It is important that potential purchasers - of annuities, mutual funds, tax-exempt municipal bonds, commodities, futures, interest rate swaps, in short, any financial instrument - understand the fees on the product and the fees a financial planner may charge.
Variable annuities are controversial because many believe the extra fees (i.e., the fees above and beyond those charged for similar retail mutual funds that offer no principal protection or guarantees of any kind) may reduce the rate of return compared to what the investor could make by investing directly in similar investments outside of the variable annuity. A big selling point for variable annuities is the guarantees many have, such as the guarantee that the customer will not lose his or her principle. Critics say that these guarantees are not necessary because over the long term the market had has always been positive while others say that with the uncertainty of the financial markets many investors simply will not invest without guarantees. Past returns are no guarantee of future performance, of course, and the different investors have different risk tolerances, different investment horizons, different family situations and so on. The sale of any security product should involve a careful analysis of the suitability of the product for the given individual.
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