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If you have an IRA, sorting
through all the investment options can be very confusing.
Unfortunately, there is a lot of hype out there and, in my opinion,
the financial services industry is great at selling the sizzle and
delivering very little steak!
This is especially true in the area of annuities. Folks purchase
variable annuities based on the belief that the principal is
protected and other guarantees. Often there is a wide gulf between
what the investor thinks a product does and what it really ends up
doing.
These are complex financial instruments that are sold using
generalities. As with anything, the devil is in the details, and the
more you know the details the less important some of these
guarantees become.
Take a look at a principal guarantee on a variable annuity. The ones
that I'm familiar with guarantee that you can withdraw so much a
year for a certain number of years, thus getting back your principal
even if the market goes to zero.
Think about that for a minute. Let's say they allow you to take 7% a
year. It would take over 13 years for you to get back your
principal. What are the probabilities of the market being worth less
over a 13 year period? Very, very small.
Or there are the guaranteed income provisions--referred to as the
guaranteed living benefit. Many investors think that these living
benefits guarantee that they will earn 5-7% a year regardless of
what the market does. They believe that if they leave their money in
and 10 years later decide to take it out that they will have earned
at least the 5-7% a year.
Nothing could be further from the truth.
These living benefit riders don't apply if you surrender the
annuity. They ONLY apply if you take a lifetime income stream from
the annuity. Even then, if you ever cash it in, what you get is
based on the actual earnings of the annuity less any withdrawals.
What you get when you cash it in isn't ever based on the 5-7%
guarantee.
Let me explain it this way. Picture two columns on a piece of paper.
The first column is the actual value of the annuity from year to
year. So if the market goes up, so does that value. If the market
goes down, so does that value. The second column is the 5-7% column.
This column takes your initial investment and increases it by the
5-7% each year.
So 10 years down the road, you decide to cash in your annuity. You
get the value in the first column; the value in the second column
meant nothing.
In a different scenario, let's say that 10 years down the road you
decide to start taking the income stream of 5%. That income stream
is based on the second column. So if the second column was $200,000
your income stream would be $10,000 a year guaranteed for life.
So far so good.
Time has passed and you have been receiving the $10,000 a year. Your
situation changes and you need (or want) what's left of the money in
the variable annuity. Here's where the surprise happens. What you
get isn't based on the value of the second column; what you get is
based on the first column less any withdrawals you've made.
Actually, every time you get a payment, they reduce both columns.
That payment affects the growth of the first column (as it should).
What if you die? Do your heirs get what's left in the second column?
No. Your heirs get what's left in the first column.
That's why I don't place a lot of value on the guaranteed provisions
associated with annuities. I expect that few people will ever use
them or get the benefits that they expect.
That's why an annuity should first be evaluated based on its
investment potential. These benefits are designed to take your eye
off of the underlying investment. Investors can have a false sense
of security thinking that changes in the market won't hurt them.
They will.
When evaluated as an investment, I believe that there are many
alternatives that are much more attractive and that allow the
investor to retain the control, flexibility and access to their
money.
Nationally-syndicated financial columnist and Certified Financial
Planner(R) Jeffrey Voudrie provides personal, in-depth money
management services and advice to select private clients throughout
the USA. He'll answer your financial question - FREE at
www.guardingyourwealth.com.
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