Before investing in an annuity, ask lots and lots of questions: Money Matters –

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Q: My financial planner recommended I invest with this big, well-known financial services company in Cleveland. He suggested it to me for long-term planning for the future.

You are limited to take any money out if needed. I wasn’t planning on doing that, but if I needed money I would not be able to get to it. It’s a 10-year plan and your interest rate would not go higher than 5.2 percent no matter what the market is doing. You also would not lose any money if the market crashed. Is this a good plan in your opinion? What are your thoughts? I am torn right now on if I should invest with them.

G.S., Cleveland

A: Your question set off alarm bells for me because I don’t think you have any idea what’s being offered to you.

If you invest with a financial planner, you’d be investing in or buying a particular product that the company is selling. Working with a big, well-known company is a good start when it comes to gauging whether an investment might be a good idea. But it’s not the be-all, end-all. Reputable companies sometimes sell a few lousy products. Reputable companies also sell products that aren’t necessarily good for everyone because personal finance is, well, personal.

Right now, you don’t even know what type of product you’d be investing in. It sounds like it’s an annuity, which is best understood as a cross between life insurance and an investment. It’s actually an investment held by a life insurance company.

First, you need to find out what the product is. If you don’t know or the salesperson isn’t clear, then obviously the decision to put money into it is “no.”

Assuming it’s an annuity, you have a lot of questions to ask. Here are a few:

  • Is someone proposing that you put most or all of your money into it? If so, that’s a red flag. It sounds like you are concerned about not having access to it and don’t have other funds to turn to. You shouldn’t put all of your money in any single type of investment or product, no matter how good it sounds. Many advisers recommend putting no more than one-third in annuities.
  • What is the issuing insurance company behind this annuity? How strong and healthy is the insurance company? Annuities are not safe or guaranteed like CD’s or other FDIC-insured deposits are.
  • Does the rate change? How often? What’s it based on?
  • You mention the rate wouldn’t go higher than 5.2 percent. What’s the guaranteed minimum rate? This is a huge question.
  • Are there any circumstances that would allow you access to some or all of the money? What’s the penalty or surrender charges?

You must get all of this information in writing. Verbal explanations or promises mean nothing.

Here are some other important facts to know about annuities:

  • Fixed annuities offer guaranteed rates of return, but not necessarily the same rate every year.
  • Variable annuities fluctuate based on market performance.
  • Index annuities are a little bit of both, offering gains that are a percentage of the return — up to a cap — of an index such as the S&P 500.

Here are some tips on what you should look for in any annuity you’re considering:

  • Contracts that don’t lock up your money too long. Ten years may be too long for many consumers. Look for five to seven.
  • The ability to withdraw some money each year without penalty. At the very least, you should be able to draw your interest and up to 10 percent of the principal without hitting a penalty, which is called a surrender charge.
  • Modest commissions. Commissions of 2 percent to 5 percent are typical and reasonable. Some annuities carry commissions of 8 percent for the sales rep. Don’t listen if you’re told the commission is coming from the company and not from the investor’s assets. That’s a load of bull.  
  • A death benefit that doesn’t deduct penalties. Some bad annuities will pay a death benefit, but will subtract the surrender charge. A consumer should expect to pay fees of a quarter- to one-half of a percentage point to not have the surrender charge deducted.
  • Clear explanations on “guaranteed” returns. If we’re talking about a fixed or bonus annuity, is the “fixed” rate the same every year? An annuity might pay 5 percent guaranteed. But maybe that’s only for the first year. After that, it might drop to 3 percent.   
  • Annuities that aren’t purchased with money that’s already growing tax-free, such as in a 401(k) or IRA. Annuities offer tax-free gains, but there’s a cost. If the money is already tax-free, it’s like carrying two umbrellas at the same time.
  • No major requirements in order to get the guaranteed return. In the case of variable annuities with guaranteed minimum returns, does the guarantee require the money to be “annuitized” at the end, meaning the lump sum must be invested long-term with a lifetime payout schedule set up?
  • Contracts that allow withdrawal in emergencies. Good products, for example, have nursing home waivers that waive all surrender charges if you need to go into a nursing home.
  • Annuities that aren’t pushed because of their life benefit feature. That might sound nice, but there’s a cost. If you really want life insurance, buy a life insurance policy. It’s cheaper, and it’s a better alternative, unless you’re not insurable.
  • Salespeople who aren’t too pushy. If an agent discourages you from getting the paperwork and/or prospectus reviewed by a trusted adviser or relative, walk away.
  • Annuities with surrender charges that are staggered. On good products, the penalties will go down as the years pass.
  • Annuities from companies with A-plus ratings. The Ohio Department of Insurance, which regulates annuities here, says no annuity is “risk free” or “guaranteed safe” and says all annuities are only as sound as the insurance company selling them.

For more information, the Ohio Department of Insurance has some excellent resources. Here are links to two great brochures that are clear and concise:

Buying an annuity – What to know:
Avoiding Unsuitable Annuity Products:

In addition, you can call the Department of Insurance to review an annuity you’re considering buying. Contact the Ohio Department of Insurance consumer hotline at 1-800-686-1526.