What Is An Annuity And How Does It Work?


7th February 2024 | 00:05:54

What Is An Annuity And How Does It Work?

What Is An Annuity And How Does It Work?

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TLDR: Tania made a mistake by moving money from her 403(b) into a traditional annuity within her retirement account. This annuity has a surrender charge, which means she'll have to pay a fee if she withdraws the money before a certain period. She's also only earning a 2% return on the annuity, while she could be earning 10-12% in a mutual fund. Tania should contact her financial advisor and see if she can reverse the transaction and put the money back into mutual funds.
[Dave's Dialogue]
Caller: Tania from Illinois, hi Dave. Thank you for taking my call.
Dave: Thanks for calling Tania. What's up?
Caller: Well, I'm hoping you can guide me. I think I've made a big mistake. My husband and I just started following your plan in August, and it's been amazing. But we're on Baby Step 2, and this has to do with an old 403(b) that I've had. Nothing's being contributed to it, but earlier in the year, back in April, we went to the financial planning services that my company sponsors and pays for. They did a full workup. I'd been having sleepless nights because my value fluctuated so much. I'd lose like $20,000, and then it would bounce back. There was a lot of risk. So, they suggested I move some money, a hundred and sixty-six thousand, into a traditional annuity within my 403(b) retirement account. It's guaranteed, so right now 30% of my $577,000 in there is now in this annuity. Now that I've started listening to you and following your steps, I'm starting to realize that was probably a huge mistake.
Dave: Yeah, and I don't know what to do. I'll contact them and see if they can reverse that and put it back into mutual funds because they said it would be like a 10-year process, taking the hit each year.
Dave: So, they put you in something inside of a retirement account with a surrender charge?
Caller: I don't know. No, these guys are absolute screwballs.
Dave: If you're in a 403(b) and it's some kind of retirement Sammy, the penalties are what your surrender charges are. And you may be stuck there. But the other thing you gotta weigh it against is you're probably making 2% on this thing instead of 10 or 12%. Okay, so if you're if you're if your surrender charge is 10%, take it and move it, put it in something that makes 10% more the first year and you recoup it.
Caller: Okay, gotcha. What makes 10%? I don't know what my surrender charge is though. The stupid thing might be 40%. I don't know. So, I'll call them and ask them about the surrender charge. I'll tell them that I'm really upset now that I learned what it is they actually sold me. They put me in a surrender charge product inside of a retirement account, which is absolutely screwed up. That's ridiculous. I mean, you've got two sets of penalties on this money now if you get if you need to get to it. Right. The government and these idiots. Yeah, so now I don't know what they're gonna do. But see what they can do to get you out. I would tell them you're not happy with them and that you want to get it moved. And see if you can lean on them a little bit and get it moved. And then get some advice from somebody else before you make any more moves, like a smart vest or a pro that has a clue what they're doing.
Dave: Wow, let's stop a second. What is an annuity? An annuity is a life insurance company product. It's a savings account with a life insurance company. There are two types of savings accounts with life insurance companies: fixed and variable. Fixed pays you basically a CD rate, one or two percent right now, which is what she's in. And it grows inside of an annuity tax-deferred, like a 401(k) or an IRA does, and you pay extra fees for the annuity. So here's what's happened: you have a tax-deferred 403(b), and they moved her into a substandard, horrible rate of return that she's paying extra fees for, and is also tax-deferred. That's redundant. You can't double-dip on this. You get one shot at this, and she already had all that for free because it's inside the 403(b). It didn't need to be in an annuity, but she got scared with her risk tolerance with the stuff moving back and forth, and so these groups dropped her into this thing.
Why is that bad? Because then they put you on a surrender charge. And then it takes seven years to be able to get your money moved out of there without getting hit with some kind of a charge and gut-punched. So there is zero times never, not a case anywhere that a fixed annuity is the answer. Never. There's always something better because a fruit jar at least doesn't penalize you when you take the money out early. And you're not making much more money on it than the fruit jar anyway. You can also do a variable annuity, which is a fine product but not inside of a retirement account. The variable annuities are mutual funds inside of an annuity, and they have some actual benefits after you've maxed out all of your retirement accounts. Not against variable annuities once you've maxed out everything and you paid off your house, but you'll need to use a variable annuity inside of there you're paying extra fees for the tax deferral and the benefits of the annuity, and you don't need to pay for that because it's already inside a retirement account.
What is an annuity?
An annuity is a life insurance company product that acts as a savings account with a life insurance company. They come in two types: fixed and variable. Fixed annuities offer a set rate of return, similar to a certificate of deposit (CD), while variable annuities offer the potential for higher returns but also carry more risk.
What is a surrender charge?
A surrender charge is a fee imposed by an insurance company when an annuity contract is terminated before the end of the surrender period. The surrender period typically lasts for a specified number of years, and the surrender charge is typically highest in the early years of the contract.
What is the issue with Tania's annuity?
Tania's issue is that she was sold a fixed annuity within her 403(b) retirement account, which is considered a poor financial decision. This is because she is paying extra fees for the annuity, and she is also subject to surrender charges if she withdraws her money early, thus reducing her potential returns.
Why is it a bad idea to have an annuity inside of a retirement account?
There are several reasons why it is generally not advisable to have an annuity inside of a retirement account:
  • Redundant tax deferral: Annuities offer tax deferral, but retirement accounts, such as 403(b)s, already provide tax deferral. Having an annuity inside a retirement account means paying extra fees for a benefit you already have.
  • Surrender charges: Annuities often have surrender charges, which are fees imposed if you withdraw your money before a certain period of time. These charges can be significant and can reduce your returns.
  • Lower returns: Fixed annuities typically offer lower returns than other investments, such as stocks and mutual funds. This is because the insurance company uses a portion of your premiums to cover the cost of the annuity contract and the surrender charges.
What should Tania do?
Tania should contact her financial advisor and inquire about the possibility of reversing the annuity purchase and moving the money back into mutual funds. If this is not possible, she should consider holding the annuity until the surrender period ends to avoid paying surrender charges. She should also seek advice from a qualified financial advisor to help her make informed decisions about her retirement savings.

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7th February 2024

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