I recently reviewed a “Guaranteed Income” annuity contract that a new client had purchased before starting work with me. Here’s how it works:
Client purchases and annuity and chooses how to invest the funds.
- The annuity has a “Guaranteed Base” on which the “Guaranteed Income” is based on
- The Guaranteed Base will grow either by 6% or the actual contract value whichever is higher.
- After 10 years the client has a choice of receiving a guaranteed income stream based on either the Guaranteed Base value which will never go down, and will go up by at least 6%/year
Sounds great doesn’t it? There are a lot of “gotchas” though.
- Although the Guarantee Base will go up by 6% per year, there actual income received is a function of the Guarantee Base multiplied by an “annuity factor.” The annuity factor is determined by the insurance company at the time the client wishes to receive income and the insurance company can determine choose whatever value they wish, meaning that the client has no idea what her “Guaranteed Income” will be.
- Fees, fees, and more fees. Try 3.45% per year or OVER $9,000/year on a $250,000 annuity. This is about $8,500 more per year than a basket of low cost index funds would cost.
- Surrender charges. They start at 8% in the first year and go down by 1% per year for the next four years.
- All of the guaranteed income will be taxed at ordinary income rates. Had the client invested in low cost index funds most of the income would be taxed at lower capital gains income tax rates.
- No inflation protection. The amount is guaranteed by it doesn’t rise each year (unless you pay even higher fees).
So what do we have:
- A future undermined guaranteed income with no inflation adjustment
- High fees meaning that the real value is significantly eroded over time vs. investing in low-cost index funds.
- Tax inefficiency.
- High surrender charges.
And this is good because . . .??