In the consumer press, the discussion about annuities usually revolves around high-cost products and shady sales techniques. Guaranteed income or withdrawal riders and equity indexed annuities do indeed tend to have high costs. Many agents pitch annuities improperly. A thorough exam of the products typically results in guarantees that are less enticing than those presented.
Those criticisms are valid, but I’m not going to rehash all that. There are low priced annuity products and ethical agents out there. The problem I have with annuities is that most clients end up creating more issues for themselves by buying any deferred annuity. Buying a bad one just makes things worse. Before deciding whether a particular product is any good, the wisdom of using an annuity at all should be evaluated.
With IRAs and retirement accounts, the tax deferral element of an annuity is moot. By using these contracts in these accounts, you greatly restrict what clients can be invested in and add in a layer of complexity that is unnecessary and often problematic.
Some products have surrender fees, and those must be navigated. They typically have provisions to keep required minimum distributions from triggering surrender fees, but even when the fees are not incurred, the withdrawals can harm the performance of the product or undermine the very guarantees that were touted to make the sale.
We have not found clients who need these extra hoops. The retirement withdrawal puzzle is complicated enough as it is.
With non-qualified money, the same issues with investment flexibility and added complexity are still there. However, in many cases, the annuity also serves to create something clients don’t need or want any more of—deferred income.
Many clients are converting money to Roth IRAs or taking retirement account distributions to reduce future taxation. Building an additional pool of deferred income makes little sense for these clients or others in modest tax brackets.
Even high-income clients can be bit by the tax bug if they aren’t careful. When they take money out, the deferred income comes out first and is taxable at ordinary income rates.
The deferred income in non-qualified annuities is income in respect of a decedent (IRD) and does not get a step-up in basis at the death of the holder. Someone will pay taxes on the earnings. In many cases, the net to surviving spouses or other heirs is hampered because the inheritors are in a higher tax bracket, or the IRD puts them in a higher bracket.
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