Annuity Insanity (Still)

“I read a column you wrote years ago as I was entering a career in insurance and mutual fund sales. It was an article explaining why using an annuity in an IRA should be considered ‘financial malpractice.’ I agreed then and I agree now. Hardly a day passes without my encountering a poor soul who has been duped into sharing their wealth with a NEEDLESS middleman. I have lost the article. Could you please revisit the subject?” — Steve Reynolds

OK. A variable annuity is an investment product sold by insurance companies (or their agents). You give them $100,000, say, and it is invested as it would be in stock-market mutual funds, except that more of your money is siphoned off in fees and its harder to get your money back out. The annuity grows without taxes until withdrawal, but then withdrawals are taxed as ordinary income.

For those few of you who may have missed it . . .

Annuity Insanity

September 4, 1996

I’ve never been too enthusiastic about annuities, for reasons I’ve detailed from time to time. They’re heavily promoted (because the sales commissions are high), but that doesn’t make them a good investment. Once you get sucked into an annuity it’s not so easy to get out or even switch managers. And you have annual administration fees and a “life insurance component” that cuts into your return.

Yes, they grow tax deferred, like a giant nondeductible IRA. But why not buy municipal bonds, which are not just tax-deferred but tax-free? Or why not buy growth stocks outside the shelter of a variable annuity? Tax on their appreciation will not only be deferred until you sell them but, very likely, subject to a favorable capital gains tax rate. (Within an annuity, any capital gains advantage is ultimately lost — the gains are fully taxable as ordinary income when withdrawn.)

So I’ve been pretty down on annuities forever — not that this seems to have thwarted in any detectable degree the army of sales folk who sells tens of billions of dollars worth every year.

But what’s really appalling is the large percentage of annuities sold to people for their retirement plans. Their IRA rollovers and Keogh Plans and so on.

This is nuts. Those funds are already tax-deferred. Why on earth would you accept the sales and administration costs of an annuity product — the only real justification for which is the tax deferral aspect — when your funds are already sheltered from tax?

If you are one of the thousands of investors making this mistake — quit it! If a financial advisor put tax-deferred annuities into your tax-deferred retirement account, I’d consider not just switching advisors but even inquiring as to possible “remedies.” You’ve been the victim of something that either is, or appears to me to verge on, professional malpractice.

(Educators with TIAA annuities: don’t be alarmed — they are a better deal.)