Beware Of Indexed Annuities
Recent Bloomberg articles have focused on the reasons why indexed annuities are bad investment choices, especially for senior citizens. Indexed annuities are typically peddled to investors using the pure psychology of downside protection with upside potential. They are attractive to investors who are afraid of market risk and marketed as being a way for those conservative investors to earn higher yields. As a matter of fact, a record $8.7 billion of indexed annuities were sold in the third quarter of 2010, up some 16% from a year earlier, according to AnnuitySpecs.com, a market research company.
Typically, the complexity of these opaque investments is downplayed along with the high commissions, long lockup periods and withdrawal penalties. Commissions can be as much as 12%, with added sales incentives such as contests with free prizes, benefits and trips. Additionally, the annuity contracts lock up investor’s money for extended periods of time since cancelling or surrendering the contract for a refund might be cost prohibitive or as much as 20%. Surrender charges are imposed for cancellation or the withdrawal of more than 10% annually during a set period ranging from 3 to 16 years. Even though the contracts permit 10% penalty free withdrawals annually, the Internal Revenue Service may charge a 10% penalty if the distributions are made before the age of 59 ½ and although investors are allowed to defer taxes, earnings are taxed as ordinary income when withdrawn. Finally, the upside potential is usually limited by performance caps, participation rates and market value adjustments by the company.
Kent Smetters, a professor at The Wharton School of Business summed it up by stating, “These contracts have really high hidden fees,” “That’s why they’re terrible ideas for older people even though they’re peddled to them.”