If you love the idea of a risk-averse investment that isn’t necessarily subject to the stock market’s ups and downs, an annuity can provide a guaranteed income stream for many years. The thing with annuities is that while you have peace of mind because of this promised income, you also have to consider that there are both good and bad annuities. This means being especially careful about signing on the dotted line unless you know everything. 

Be Careful of High Fees

The very first thing to watch out for with an annuity is the fees, and this could be a dead giveaway the annuity you bought is trash. It’s super important that anyone looking at an annuity as an investment for the future knows the costs associated with various annuity types, which include sometimes ridiculously high fees that will eat into your income potential.

Commission Fees

When choosing an annuity, you must consider that a commission fee could eat your money right from the start. This fee can range between 1% and 8%, a gut-wrenching amount you must claw back over the annuity’s life, and you lose this money almost immediately as you have to pay the commission upfront. 

Riders

Unbeknownst to many, when they first look at picking up an annuity, any rider you add will include additional fees. If these fees cost upward of 2%, it’s a pretty good sign that the annuity you bought isn’t necessarily trash, but better options exist. Adding a rider alone isn’t a sign of a lousy annuity, as life’s needs change over time, but your hope should be to find one with fees closer to 0.25% or 0.5%, which would provide less sticker shock. 

Surrender Charges

If you need to withdraw money from an annuity early on before it’s entirely “vested” per its original terms, you could be looking at some nasty fees. These fees might be upward of 10% penalties, another gut-twisting reduction in how much money you must spend to make an annuity work for you. Look for an annuity with lower surrender charges, which would be a good sign to move forward. 

One thing to remember about surrender charges is that you can pay them if you want to get out of the annuity altogether. This would mean surrendering the contract for its current value, but it’s the most straightforward option if you wish to cancel a contract altogether.

Alternatively, you can work through a 1035 exchange, swapping out your existing annuity for a new one without incurring a surrender charge (or tax penalties). This would be a good choice if you still want an annuity option for retirement but are looking for more favorable terms. 

Reduced Returns

Ultimately, fees are a genuine concern because if you have a variable annuity earning 6% annually and paying 3% in fees, your actual return is halved. You should know these fees before you ever sign on the dotted line, giving you a complete line of sight into what kind of real return you are looking at before taking action. 

The bottom line with fees is to demand any documentation about potential and automatic fees before you sign on the dotted line. You should be well versed in the possibility of any expenses that could pop up over time so there are no surprises during the life of your annuity. 

Concerns Over Earning Caps

Another immediate concern with an annuity is its return, which can dramatically impact its performance, especially if you choose a non-fixed annuity. In this instance, an enormous flag would be any monthly or annual cap restricting your earnings without factoring in market performance. 

For example, if your annuities earning cap is 3% for the whole year, but the market is up 10% year-over-year, you’re missing out on 7% growth. Compounding this missed earning potential over the next 10 or 20 years means you’re missing out on thousands, if not hundreds, of thousands of dollars. 

Disappointing Levels of Flexibility 

Shifting attention toward annuity flexibility, you need to be mindful of the annuity you purchased when you discover it has a disappointing level of flexibility. Suppose you have an annuity with a strict limitation, like a surrender period of upwards of 10 years (or longer). Accessing this money any sooner than this can be costly due to higher penalties, which is not a good sign. 

Building on needing money early in emergencies, some annuity contracts limit emergency withdrawals to 10% of the total account value. If you have an annuity of $100,000, you are limited to no more than $10,000 in any emergency. This is, in a very literal sense, a disappointing level of flexibility as it could impact your ability to pay off bills on time. 

The bottom line is that life circumstances can and do change, so you want as much flexibility as possible if you need to adjust your financial situation quickly. If an annuity cannot help with these circumstances, it’s a good sign it was a trash choice. 

Not Enough Transparency

The lack of transparency around an annuity builds on the concerns that don’t come up enough when researching this retirement option. Generally, this concern starts when you receive aggressive sales tactics from insurance agents who want to sell you the annuity that earns the highest commission. This is a significant and frequent issue as these sales individuals might push you toward the wrong annuity, which could mean financial surprises when the time comes to start cashing in. 

You should ask detailed questions and demand clear documentation. Suppose you have an agent who can’t or won’t give you clear and direct answers about fees, commissions, and, most importantly, any risks related to annuity products. In that case, you should walk away from any conversation. Transparency should be essential to any decision-making process regarding your financial future. 

Troublesome Contract Terms

Stuck somewhere in the conversation around not being super transparent would be an obscurely worded contract that would make it more difficult for you to understand what you are signing. If you have any concerns you might want to check out, ask a financial advisor or an attorney to review any documentation with you. There is no shame in having someone more qualified look at something that dramatically affects your financial well-being during retirement. 

Tips To Identify Red Flags

The first and most crucial tip to identify red flags around an annuity product is comparing its fees with other retirement products. Use an online annuity fee calculator, like this one from Charles Schwab, to help ensure you don’t spend more than necessary.

Some insurance companies will work with you on fee reductions or enable increased withdrawal flexibility if you have concerns. There isn’t endless flexibility on their end, but if they are working with you, this is a good sign you should continue moving forward. 

Another recommendation to avoid red flags is to ask for a breakdown of variable annuity returns for the past few years, which is perfectly reasonable. Knowing how past performance played out can tell you whether the fund is a good one or not. 

Lastly, reach out to a financial advisor if you have any concerns. A fiduciary advisor is bound by law to act in your best interest and doesn’t work on commission, so they will be straight with you about whether or not you’re looking at a worthwhile annuity option. There is no harm in asking for help, and it might save you money in the long run. 

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