Q: Several years ago, my financial adviser got my wife and me to convert several of our IRAs, and Roth IRAs, to annuities. Both are tied to the market and have done so-so. Now after seven years and when the commission is just about up he wants us to convert to the Jackson National Perspective II Fixed and Variable Annuity. I am 59, and my wife is 54. I do not think this is a good idea to switch and pay expenses again. Thoughts?
A: The annuity market is incredibly complex, offering seemingly countless variations on the underlying product. The annuity category you’re dealing with is the “variable annuity,” essentially a product mixing elements from life insurance, mutual funds and tax-deferred retirement savings.
The actual recipe for various variable annuity offerings can differ significantly, but the typical product shares a number of common features. Variable annuities come with a death benefit and many mutual fund-like accounts to choose from. The variable annuity is purchased with after-tax dollars, but the investment earnings compound tax-deferred until withdrawal (usually during retirement), when any gains are taxed as ordinary income.
To me, variable annuities are a niche product for those with enough savings to have maxed out their retirement savings at work, their IRAs, their emergency savings and other taxable savings accounts. If they still have money left over to put to work for the long haul, it makes sense to investigate the variable annuity market. While the complexity of the market is a drawback for many savers, it allows the knowledgeable saver to find or design a tailored product that meets a particular need.
But for most of us struggling to get by, the typical variable annuity has too many drawbacks. I don’t like steep surrender charges. They limit financial flexibility. Surrender charges can run as high as 7 percent in the first year of the contract, 6 percent in the second, 5 percent in the third and so on during the first five to 10 years of the contract. Variable annuities tend to be a high-fee product since many charge higher expenses on their investment options than comparable mutual funds do.
Following the traumatic market plunge of 2008 the kind of variable annuity, designed to offer investors the ability to share in some of the upside when the market is strong while limiting downside risk, grew in popularity. My problem with variable annuities that limit downside market risk while offering some upside gain is that the mechanics of the product are typically opaque. It’s difficult to understand exactly what’s going on.
I would go with your instincts. Switching from one annuity to another is usually not a good idea. After all, you’re essentially restarting the surrender charge clock. Question is, does the new product offer enough additional benefits compared to your existing investments to justify the switch? I wouldn’t make a move without a return large enough to offset the additional fees and restrictions.
There is a much easier and far cheaper way for lowering your exposure to the vagaries of the stock market. Shrink the portion of your portfolio exposed to the stock market down to the sleeping point. Invest your equity money in low-cost broad-based equity index funds. For the rest of your diversified portfolio, stick with high-quality, low-cost investments, such as Treasury Inflation Protected Securities.
Chris Farrell is economics editor for “Marketplace Money.” His e-mail is email@example.com.