05 Nov Are annuities a paycheck for life or fee-laden mistake?

 Q. I’m 65 and I just retired. When my sister retired, she used her 401(k) to buy an annuity, and now she gets a monthly “paycheck.” She loves it, but I’ve always head bad things about annuities. What do I need to know?

A. When it comes to annuities, Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Boonton, turns to Shakespeare’s Hamlet: “Nothing either good or bad, but thinking makes it so…”

“I do not think that annuities are good or bad. They are what they are,” he said. “In the right situation they can be great and in the wrong situation, they can be terrible. It depends on your situation.”

Of course, a steady stream of income in retirement seems like a great deal, but great deals come at a price, said Eric Furey, a certified financial planner with RegentAtlantic Capital in Morristown.

“You need to be weary of what you can’t see when it comes to annuities,” Furey said. “Mainly, what you need to look out for is the opportunity cost of buying the annuity, the annuity’s ability to fight inflation, and whether the annuity helps achieve your financial goals.”

Furey said the opportunity cost of buying an annuity refers to what the money you use for the annuity could instead be invested in if the money wasn’t going into an annuity.

“An immediate annuity’s payout is typically based on the current level of interest rates,” he said. “With interest rates at historic lows, you are locking in a low assumed rate of return for the rest of your life. You may be able to achieve a higher return if you took more risk in a balanced portfolio of stocks and bonds.”

The second and third caution signs with annuities are inflation and the ability to achieve your financial goals, he said. The annuity payment you receive in the early years may fund all of your expenses, and could even provide a little extra that you can save in retirement But as each year goes by, the gallon of milk, gasoline, healthcare and just about everything will slowly increase in price while the immediate annuity payment stays stagnant, Furey said.

“This becomes problematic in the later years of life since buying a quarter gallon of milk instead of a full gallon typically isn’t an option,” he said.

Lynch said if you trade a lump sum for an income stream, you should be sure not to invest all your money in the annuity. If you have to invade the annuity and get more money they what is guaranteed, then you will lose some of the benefits, he said.

He also recommends rather than just buy a produce from a salesman, you sit with a financial advisor who can examine your entire financial life and create a plan for you.

“Once you have a plan, then you figure out what products that you need to make that happen,” Lynch said. “If you go to a person who only sells annuities, more likely than not, they will have a contract with your name on it ready before they even met with you.”

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You also want to reveal the white elephant in the room and ask the annuity salesperson how much he or she will earn on commission if you buy the annuity.

“Generally I prefer the advisor gets paid a smaller amount up front and then an annual trail of income,” he said. “The reason is that if the first advisor does not work out, you can switch advisors and the new advisor will get paid. If they are paid all upfront, what is the incentive to service the account?”

Also be sure to understand the financial stability of the insurance company that writes the annuity contract.

“Annuity is a promise to pay,” Lynch said. “If they are making the promise, you want to make sure that they can fulfill the promise as they will be paying for the rest of your life.”

Lynch said while there is a state reinsurance program that will cover you up to certain limits, you really don’t want to have to rely on that during retirement

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This story was first posted in November 2014.