8 Common Mistakes Annuity Buyers Don't Know They're Making

Written by Hersh Stern Updated Wednesday, January 3, 2018

The right annuity can bring you financial security and peace of mind. This is why it pains me to speak with people who have made hasty or badly-advised annuity purchase decisions.

By working with the right agent – one who is truly invested in helping you make the very best choice for your future – you can avoid these 8 common pitfalls:

1. Buying an annuity you don't fully understand.

If you don’t understand it, don’t buy it. It's just that simple. Believe it or not, I speak to people every day who try to explain to me what they think a particular annuity will do for them -- based on what an agent or friend told them. Yet, they're often just plain wrong.

The annuity they have in mind does not accomplish what they think it does. So my Number #1 suggestion is: Find someone who is willing to spend the time to make sure you completely know what your annuity will and will not do!

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Some types of annuities are simple and straightforward, others are very complex, with many bells and whistles. Please be sure you know what you are buying.

2. Not understanding the differences between the various types of annuities.

Annuities come in all shapes and sizes. Some can be cashed in, others cannot. Some pay you income immediately, others are designed to grow for years before withdrawals are taken out.

So before you rush into a decision, be sure you understand the type you are buying and whether it is right for you.

While this may seem overwhelming, the good news is that knowing what's available ensures that you will get the benefits you seek. Find someone who will take the time to match the right annuity to your needs.

3. Not understanding the terms of your annuity contract.

Every annuity comes with brochures and disclosure statements that explain the terms. Be sure you understand them before you buy. If some of the terminology is confusing or foreign: ask.

This is an important decision, and you should take the time to be sure you fully understand what you are buying.

4. Not asking the right questions.

This tip is related to the previous suggestions. I always try to reassure potential clients that there are no “stupid” questions when it comes to annuities. Whether you have worked in finance all your life or whether it sounds like mumbo-jumbo to you, ask every “what if?” you can imagine.

This is how your annuity will help you sleep well at night. What does your annuity promise? Can that change? What happens when events change in your life? Is there any flexibility? How do you get at your money? And at what cost?

What other mistakes should I be looking out for?

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Comments (16)

  1. Anthony Christensen:
    Nov 19, 2014 at 04:28 PM

    I currently have an annuity that will pay me 5% of a withdrawal value of $174,000. The current cash value of the annuity is $162,000. The withdrawal value currently grows at 6% annually. I am 62 years old. Am I better off pulling my money out of the annuity and rolling it into a Traditional IRA?

  2. Hersh Stern:
    Nov 20, 2014 at 08:51 AM

    Hi Anthony,

    Based upon your question, I did a few calculations for you.

    First, 5% of $174,000 is $8,700 (or $725 per month). Next, using your cash value of $162,000, I ran a set of immediate annuity quotes. Based on a “single life with cash refund” option, the immediate annuity guarantees more income than your current annuity.

    For example, United of Omaha (A+ rated by A.M. Best) is quoting $799 per month, compared to the $725 per month your existing annuity will pay.

    I hope that you find this information helpful. If you have any additional questions, please let me know. I’m very happy to help however I can. You can call me at 800-872-6684, or leaving another comment below.

    -Hersh

  3. Dave:
    Feb 25, 2015 at 12:47 PM

    I am interested in an immediate annuity to bolster my income. I am in need of an extra $99 a month. Is there a minimum premium required by the insurance companies?

  4. Hersh Stern:
    Feb 25, 2015 at 01:30 PM

    Hi Dave-

    Yes, every company has a minimum premium it will accept in order to issue an annuity. Additionally, many companies will not sell an immediate annuity if the monthly income is below $100. In a separate email I’ve sent you quotes from the companies we represent based on $100/month. Please contact me again if you have any other questions.

    Hersh

  5. Blair:
    Jun 08, 2015 at 02:28 PM

    We are a couple, in good health, in our late seventies and early eighties. We are thinking about applying for a reverse mortgage on our full time Florida home and using the proceeds to buy a fixed annuity for the income stream. This would enable us to conserve other cash assets for other purposes and give us peace-of-mind. Is this a reasonable and viable strategy? Are we overlooking something?

  6. Hersh Stern:
    Jun 08, 2015 at 02:30 PM

    Hi Blair-

    The general rule in the insurance industry is that it would be unsuitable to borrow money in order to purchase an annuity. If you need to take out a loan to be able to pay for an annuity - and a reverse mortgage is a loan - then you're probably not a good candidate for one.

    Now, I certainly understand your reasoning. At this stage in your life you feel it’s more important to be able to create a guaranteed income stream from your assets. And it wouldn’t make much sense to put your money in a CD or MM account since those won’t accomplish your goals.

    However, it also wouldn’t make sense to buy an annuity that earned you 2.00% to 3.00% with money from a reverse mortgage that costs you 4.00%.

    In recent years, insurance regulators in 29 states have filed suits against agents who recommended to their clients that they use proceeds from a reverse mortgage to purchase life insurance, a long-term care policy, or an annuity.

    Should this be a hard and fast rule?

    I can think of situations where some flexibility by the regulators would be in order. For example, imagine we’re back in 2007 right before the catastrophic collapse in home prices. You called me to say you wanted to take out a $100,000 loan from the $150,000 equity in your home and you wanted invest the money in an income annuity. I would have to tell you I’m sorry but I’m unable to help you. A year later, you call me to say the value of your home was cut in half and you noticed that annuity rates also had dropped to 2%. Should you have been discouraged from buying your annuity when interest rates were 6%?

    I wish I could help. Whether a reverse mortgage is a good deal in your situation depends on many factors which you should review with a competent financial planner. Best of luck!

    Hersh

  7. John:
    Mar 09, 2016 at 11:47 AM

    The $65,000 I entered is an estimated rollover amount. I won't know the exact amount until time for the rollover.

  8. Hersh Stern:
    Mar 09, 2016 at 11:47 AM

    Hi John-

    That’s quite common and it’s not a problem. When the insurance company receives your transferred premium, it will adjust the monthly income amount in your application to be proportional with the ratio of income to premium you see in our online quotes.

    Hersh

  9. Raymond:
    Aug 24, 2016 at 04:13 PM

    Your quote for a joint annuity with a premium of $125,000 coming from a savings account is a monthly income of $1,056 [Mass Mutual] and a taxable amount of $0. Is that correct? I pay no tax on the monthly income?

  10. Hersh Stern:
    Aug 24, 2016 at 04:16 PM

    Hi Raymond,

    Your quote is 100% correct. Your income will be completely tax-free until the point that you’ve received your full $125,000 premium back. At that point, your income will become fully taxable because it will become all interest. According to my calculations, this will take approximately 119 months (just under 10 years) to occur.

    -Hersh

  11. Jeff:
    Aug 24, 2016 at 04:40 PM

    I was thinking of putting my 401k Qualified funds into a annuity. The question I have is: after I am dead will the remaining funds go to our beneficiaries on a step up basis? Meaning no taxes due to Uncle Sam.

  12. Hersh Stern:
    Aug 24, 2016 at 04:43 PM

    Hi Jeff-

    No, your beneficiaries will owe taxes.

    What you’re describing is an inherited IRA situation. You are rolling over your 401k funds into an IRA annuity. Your beneficiaries will essentially be inheriting your IRA.

    They will have several options when they inherit your IRA, and the option they choose can have a big impact on how much taxes are owed. By the way, the rules are different for spouses that inherit than for nonspouse beneficiaries.

    Your beneficiaries will be able to cash out your account even before they reach age 59½ and still not pay the 10% early-withdrawal penalty. But they will have to pay taxes on the money received.

    If your nonspouse beneficiary doesn’t start taking withdrawals by December 31 of the year after your died, then he or she must withdraw all of the money in the account within five years. Otherwise, they must take minimum distributions from the account based on your own life expectancy, starting by December 31 of the year after your death. These required withdrawals are similar to the required minimum distributions (RMDs) for IRA holders over age 70½, but they use a different life expectancy table. The withdrawals will be taxable, but the money not withdrawn can continue to grow tax-deferred in the account.

    A spouse who inherits a traditional IRA has more choices. He or she can roll the money into their own IRA, so they don’t have to start taking required minimum distributions (based on their life expectancy) until they reach age 70½. But they’d have to pay a 10% early-withdrawal penalty for money they take from the account before age 59½.

    If you passed age 70½ and had already started taking RMDs before you died, then your beneficiary can continue to take annual withdrawals based on your life expectancy schedule or take withdrawals based on his or her own life expectancy.

    The rules are different for Roth IRAs, which can usually be inherited tax-free.

    For more information about these rules and the IRS life-expectancy tables for required withdrawals, see IRS Publication 590, “Individual Retirement Arrangements.”

    As you continue to review our quotes and web site information, please feel free to contact me with any questions or even to discuss your retirement plans. I know this can get complicated.

    -Hersh

  13. Stanley:
    Aug 25, 2016 at 10:19 AM

    My wife, age 77, has heart failure and had a stroke on May 1, 2008. My health is OK; I am 79. Does her health make the monthly payout higher on a Joint Life single premium annuity ($100,000) for any option such as Cash Refund, Life with 10 years certain, etc.?

  14. Hersh Stern:
    Aug 25, 2016 at 10:20 AM

    Hi Stanley-

    Sure, your wife’s medical condition may have some impact because she is younger than you so her health issues would cause her to be treated actuarially older than her date of birth or chronological age. On the other hand, adding a cash back or beneficiary option can significantly reduce the impact of a rated age calculation. Rated age quotes are highest when the buyer assumes the risk he or she may die sooner.

    I’ve written a detailed article about this topic which I hope you’ll find informative. You can read it at this link:
    https://www.immediateannuities.com/rated-age/

    -Hersh

  15. Shirley:
    Aug 25, 2016 at 12:38 PM

    Regarding QLACs, if an IRA account has $200,000 and the 401K account has 800,000 but the 401K plan does not have an annuity option, can I purchase a QLAC with IRA funds or would I have to transfer some 401K funds into the IRA first and then purchase the QLAC? Hope the question makes sense.

  16. Hersh Stern:
    Aug 25, 2016 at 12:38 PM

    Hi Shirley,

    You can definitely purchase a QLAC using your IRA funds.

    However, in your scenario you can only purchase a QLAC in the amount of $50,000 (25% of your traditional IRA balance as of 12/31) in this calendar year. If you want to purchase a QLAC for the full $125,000 allowed, you will have to wait until 2017 and have an IRA balance of at least $500,000 by 12/31/2016. This would require rolling over some of your 401k monies into a Traditional IRA this year.

    -Hersh