You may have invested some or all of your nest egg in annuities. Annuities can be useful tools as part of a diversified investment portfolio. However, if you put all of your investable assets in annuities, this is putting all of your nest egg in one basket. This is rarely the wisest investment strategy. In addition, are you aware of all of the terms and conditions of your annuities, especially when the time comes that funds are needed out of the annuities?
You may have been told, as many of my clients have been told, that you pay no commissions on annuities. In actuality, you do pay commissions in the form of surrender charge penalties. If you need the funds and have to make a withdrawal out of your annuity before the surrender charge period expires, substantial surrender charge penalties may have to be paid out of the principal of your annuity. Sometimes you are limited to a certain amount or percentage that you can take out of your annuity on an annual basis without penalty. If you take any more than allowed, you may also be subject to these penalties.
Annuities are some of the highest commission financial products available, so there is no shortage of people willing to peddle them. These commissions increase the higher the surrender charge and the longer the surrender charge period. I have seen surrender charge penalties as high as 20% and for periods as long as 20 years. The year one surrender charge penalties often approximate the commissions paid to the annuity seller.
I had one case in which an 85 year old man was sold an annuity with a 15 year surrender charge period. In that particular case, realistically there was no way that he would access those funds during his lifetime without incurring the penalties.
If you are purchasing an annuity, especially if you are a senior, look carefully at the surrender charge percentages and the surrender charge period. Only purchase those annuities which you do not have any expectation of a need for those funds during that period or can withdraw funds without penalty. Make sure surrender charge penalties are waived upon disability or death.
There are many different types of annuities. Two types of annuities I usually see are immediate annuities and deferred annuities. With an immediate annuity, you deposit a sum of money with the annuity company in exchange for a monthly payment over a certain period of time or over your lifetime. The income earned on the funds is only taxable when the annuity payments are received. You may want to invest in an immediate annuity for the security of knowing that you will be receiving a regular monthly check, like a pension.
However, there are things that you may not realize when you have an immediate annuity. Firstly, you may not have access to the principal amount. If you need more than your monthly amount you may not be able to withdraw it. Some immediate annuities may allow you to take additional amounts out, but it could effect your future payments or trigger surrender charges.
Secondly, with an immediate lifetime annuity, and sometimes after a certain minimum amount of payments, the annuity payments will cease upon your death. You will be unable to leave any of that annuity to your heirs.
Lastly, the immediate annuity may not qualify as a Medicaid compliant annuity because it is not considered “actuarially sound” under the Medicaid rules and/or the State of Michigan is not designated as your primary beneficiary to repay Medicaid expenses. If an annuity is not a qualifying Medicaid eligible annuity, it would be considered an available resource and may disqualify you from having Medicaid pay for nursing home care, even if all of your other assets are spent down.
One type of immediate annuity which I have heard heavily advertised as a retirement security tool is a charitable gift annuity. If you are charitably minded, a charitable gift annuity can be a great way to provide for your favorite charity, get a current income tax deduction and receive a stream of payments over the rest of your lifetime.
However, when you give a lump sum to a charity in exchange for an immediate annuity, a portion of that lump sum goes outright to the charity as a charitable gift. The remainder is then used to fund the monthly or other regular annuity payments for the rest of your lifetime. The result is that you usually receive smaller annuity payments than if you had invested the entire lump sum in a non-charitable annuity. This is fine as long as you understand this going into the arrangement.
With a deferred annuity on the other hand, you do not receive any payments until a later date. The nice thing about deferred annuities is that you can defer taxes on the income earned on those funds until you take the money out of the annuity.
Deferred annuities by their nature are not Medicaid qualifying and therefore need to be redeemed in order to qualify you to have Medicaid pay for nursing home care. If you redeem the annuity during the surrender charge period, you would incur surrender charges. There are a few annuities out there that will waive these surrender charges in certain circumstances. If you are a senior, make sure your annuity has hardship waiver of the surrender charges in case you need to withdraw funds to pay for home care, assisted living or nursing home care services.
Even though the laws have changed, there are financial advisors still encouraging seniors to purchase “convertible” annuities that are essentially deferred annuities that can be converted into a Medicaid compliant immediate annuity at a later date. Although after conversion these annuities may be considered Medicaid compliant, when you are receiving Medicaid, all of the income from the annuity would have to be used for nursing home care. Not only that, if there is anything left of the annuity after your death, the State of Michigan must be the primary beneficiary to pay back Medicaid expenses.
So realistically, you are protecting few assets with this type of investment. These convertible annuities were once very useful tools for Medicaid planning. However, changes in the Medicaid laws in recent years, especially since 2006, have limited the usefulness of “convertible” annuities for that purpose.
Seniors should be especially wary of annuity sellers who appear to be estate planning outfits or veteran organizations. These annuity sellers will often use informational seminars with food to lure seniors. The seminars are designed to frighten you into protecting your assets by purchasing a trust estate plan or applying for veterans benefits, which they will provide.
You are then told that your estate plan won’t work or you won’t qualify for veterans benefits unless you consolidate all of your investments into annuities with them. I understand that the Michigan Attorney General and Governor’s offices are investigating these schemes. These outfits are usually just trying to peddle annuities with high surrender charges, long surrender charge periods and high commissions any way they can.
You also may have been told that there is a “guaranteed” interest rate or that your principal is protected. Review your annuity carefully because that is not always the case. Your annuity may be tied to the stock market with mutual funds or a stock market index such as the S&P 500.
Since annuities are only a part of a diversified investment portfolio, your investment advisor should be able to advise you accordingly. If your “financial advisor” only recommends or provides annuities, you should have at least one other financial advisor to provide diversified comprehensive financial investment advice to coordinate with your annuity provider.
By: Matthew M. Wallace, CPA, JD
Published edited July17, 2011 in The Times Herald newspaper, Port Huron, Michigan as: Not all annuities created equal