Three mistakes annuity owners should avoid

Annuities are becoming one of the most common financial products used when planning for retirement. Buyer demand, fueled by higher interest rates, market volatility from the COVID-19 pandemic and subsequent inflation have all contributed to recent record-breaking sales.

In 2023, total annuity sales hit $385 billion, 23% higher than the record set in 2022, according to LIMRA. The trend continued in 2024, with annuity sales reaching a record-breaking $113.5 billion in the first quarter. Despite their growing popularity, these products can be one of the most misunderstood financial products available to consumers today. This lack of knowledge can lead buyers to make mistakes.

Mistake No. 1: Buying the wrong annuity

One of the first mistakes consumers can make when purchasing an annuity is purchasing one that doesn’t fit with their overall retirement plan. Annuities are insurance contracts issued and guaranteed by an insurance company. There are four main types, and each comes with different features.

Single premium immediate annuities are annuities that immediately provide a guaranteed income stream. SPIAs are purchased from an insurance company. The insurer then guarantees that it will pay the annuity owner a fixed sum of money for a specific period of time. 

Fixed annuities or multiyear guaranteed annuities are purchased by a consumer for a specific period of time, usually between one and 10 years. When these are purchased, the insurance company guarantees the principal and also guarantees a set interest rate for the duration of the contract.

Variable annuities work a little bit differently. Once they are purchased, the insurance company buys mutual funds chosen by the consumer from those offered by the insurance company. This means the value of the product can go up and down with the stock market. Most variable annuities provide a guaranteed death benefit that will be paid out to a beneficiary when the investor dies. Most of them also offer an income rider, which provides the purchaser with a guaranteed amount of income once activated for an annual fee.

Fixed indexed annuities, or indexed annuities, are purchased from an insurance company, and in exchange, the insurance company guarantees the principal never decreases in value regardless of what the stock market does. The principal is then linked to, but not directly invested in, a stock market index such as the S&P 500.

Not understanding how annuities work and the various available types could lead consumers  to make a purchase that doesn’t fit into their plan. For example, most people who buy SPIAs purchase them because they want to guarantee that they’ll never run out of money. Alternatively, a younger investor in their 30s or 40s may choose to buy a variable annuity because they can afford to take on that risk. 

Mistake No. 2: Failing to review the annuity

Life changes over time, and the annuity someone may have bought may no longer serve their needs for a multitude of reasons. For example, a client may have purchased a variable annuity that has a lot of growth potential. This might make sense if they’re decades away from retirement, but as they get closer to retirement, their risk tolerance will likely be a lot lower. In this case, it might make sense to exchange their variable annuity for a fixed annuity. Variable annuities also have annual fees and expenses that they may no longer want to pay.

An evolving market and changing interest rates are another reason to regularly review your client’s annuity. Annuities sold 10 or 15 years ago may look very different from what’s on the market today. There may be new features that are better suited to clients’ needs. 

If a client purchased a time-sensitive annuity such as a MYGA, it’s important to pay attention to current interest rates. It’s possible that the renewal rate the client is offered when the term ends might not match other rates that are available in the wider market. If this is the case, renewing the contract may not be the best choice.

Mistake No. 3: Not understanding the surrender period

The surrender period is the time the owner must wait before they can withdraw funds from an annuity without being penalized. These periods are designed to discourage an annuity owner from taking the money out early or canceling contracts. If money is taken out during this time, they will be charged a surrender fee, which is a percentage of the withdrawal amount. Surrender periods and fees can vary depending on the terms of the annuity, so make sure your clients understand the terms before they make the purchase. 

Annuities can be complicated due to their various features and benefits. If your client is considering purchasing an annuity or has questions about their current annuity, you can help them determine what type of annuity to purchase, evaluate whether their existing annuity aligns with their retirement plans and goals, and make sure they understand the terms of their annuity to avoid any penalties.

Jason “JB” Beckett has been an advisor for 24 years and is the founder and president of Beckett Financial Group, with offices in West Columbia and Greenville, S.C. Contact him at [email protected].