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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

Is Buying an Annuity a Mistake? 5 Red Flags to Watch For

Too often, buying an annuity is a mistake. It doesn't have to be. Watching for 5 simple, easy to identify red flags can help you avoid a costly mistake.

People buy annuities looking for a steady income stream and reduced risk. Unfortunately, too often, they get substandard products. Bridget Sullivan Mermel CFP(R) CPA and John Scherer CFP(R) talk about how to sort it out.

One of the big things is that—when you look at them, look at the number of moving parts. All annuities have mortality and expense charge. What if there is mutual fund charge? Upside protection? Payout charge? Longevity charge? How do you know what you have?

Just like investments—if you don’t know what you’re buying and you can’t explain what you’re buying to someone, you shouldn’t buy it. You should be able to understand all of your moving parts. The golden question to ask—what is commission and how much money do you make on this? 4 to 8% commission for agent is high.

Guaranteed payments sound good, but make sure you understand how the agent and insurance company is making money.

Moments of interest:

00:00 Hello!

01:35 When annuities make sense

03:30 One big thing to look at to evaluate annuity

05:05 Second big thing to look at to protect yourself

07:45 Third red flag

08:35 Fourth caution

09:00 Fifth red flag

Here's Bridget's firm website:

John's firm website:

For advisors around the US:

Thanks for watching and please subscribe!


Bridget: Buying annuities. What to watch out for. Hi, this is Friends Talk Financial Planning. And I'm Bridget Sullivan Mermel.

John: Hi. And I'm John Scherer. Bridget and I both run fee-only financial planning practices, and we get together to talk about important things that can help our viewers. Before we get started talking about annuities, Bridget, which is a great topic—I’m excited as funny as that sounds—I want to remind all the viewers to subscribe.

Hit that subscribe button. That helps other people find this information, helps us move up on YouTube. So with that, tell me about annuities. What's been coming up in your client conversations and what's on your mind today, Bridget?

Bridget: Well, John, what I really want to talk about are pitfalls and what to really watch out for. I generally don't recommend annuities, but I realize that they appeal to people because a lot of people listen to the siren song of “I don't want to run out of money, and this will give me a guaranteed set of income” and other features that are with annuities.

So I can understand why it would appeal to people who really just want to keep it simple. So I am really interested in doing the show where we talk about what to watch out for. What would you say is the number one thing to watch out for when you're thinking about getting an annuity?

John: Yeah, that's a great question. And I'm going to turn it on its head just a little bit and talk about how annuities can make some sense and be a really good tool but for a small subset of people. Most people don't need and shouldn't really have annuities. So who does it fit for? It's for people who are worried about running out of money in retirement. And, of course, everybody thinks, “Well, listen, I don't want to run out of money.”

But annuities are primarily for folks who say, “Listen, I've got longevity in my genes, in my family history. What if I live to 110? That's a long time to go. And I want to have some of that security from a cash flow, just like Social Security, to be around for as long as I live. I'm counting on those payments.” That's the place where it really fits.

And so, who it's not for is people that sort of don't have any money, who are on the low end of things, saying, “Geez, I'm going to be living on Social Security,” and the people that are super on the high end, saying, “Listen, I have enough money. I'm not going to have to worry about this stuff.”

So it's sort of in that middle of ground where you go, “Hey, I probably got enough money, but golly, I’m cutting it close, and I want to have some of that security cash flow in retirement.” Wo that's the place where I really think it fits. Unfortunately, what we see a lot of is that that's not who buys these. It's people who are in their 40s or in their 50s and have enough money and aren't worried about the cash flow thing. It's some of the other investment risk things that get pitched.

And it's not like those things can't work, but I'll tell you, I've never seen one that I thought, “This is a good investment.” Kind of to your point earlier, I've never recommended an annuity from an accumulation standpoint, from a good investment standpoint. For retirement income in certain circumstances, limited places, sure, but I've just never looked at one objectively and thought, “Hey, this makes sense.”

And one of the big things is that when you look at an annuity, if you might have one or if you're considering buying one, is the number of moving parts. Some of these annuities have extra fees. Every annuity has a mortality and expense charge. If it's a variable annuity, there's the mutual fund charge underneath that. And then there might be a longevity risk charge to it. There're limits on the upside—how much you can get—and then there's payout charges on this.

And when there are 15 moving parts and every one of them affects all the other ones, how can you really, as a consumer, know what you have? And one of the golden rules that we use anyway with our investment thought process is if you don't understand what you're buying from an investment standpoint, you shouldn't be buying it. It is not that complicated to be financially successful and secure and safe and all those things. If you don't understand it, that's a giant red flag.

So that's one thing. If you walk away and you can't explain to your spouse or to your neighbor, to your sibling, “Hey, here's what I'm buying and here's why. And here's all the moving parts.” If you can't explain it, that's a problem. Think about this, Bridget. You can explain when you're buying a CD, right? You can probably do that rather succinctly. Everybody can probably do that rather succinctly, right? Same thing with a mutual fund. Most people these days have some working understanding of annuities after listening to you or me talk about it. They think, “Yeah, Jeez, that makes sense.” If it doesn't, then you should pause and question. So that's one thing.

And I'll tell you about another thing on how to protect yourself from making a mistake. The golden question to ask the person that's suggesting you're buying an annuity is: What is the commission, and how much money do you make on this? And with all these other variables, all these things that go into it, it can be really confusing, but yet it sounds good. I think there's some possibility. And take a look at what they're making. We see agent commissions at 4%, 5%, 8%. And you go, “Golly. If the agents making that kind of percentage and the insurance company is making money on it, they're definitely not selling it at a loss.”

We had a client that was considering one of these, and he said, “Boy, I get the first 2% a month of return, and it never goes down. And they're going to give me a 5% bonus. If I put $100,000 in, I will start earning interest on $105,000.” And we had this conversation about it, and I said, “Okay, so they're giving you $5,000, 5%, and it never goes down. And you get the first 2% each year—24% a year goes to you before they make any money. And we know the insurance companies making money. Can we agree on that? Yeah. And, well, you need to ask the agent.”

He said, “Oh, I asked the agent, they make 5%.” I said, “They're paying the agent $5,000, they're giving you $5,000, you get the first 24%. What's going on here?” And he said, “Yeah, that doesn't sound correct.” And you dig into it, and it turns out that, oh yeah, technically, that's right, but when you look at some of the clauses and some of the hidden language in that 110-page prospectus, all the sudden you go, “Oh, yeah. I mean, those words are correct, but that is not what I thought was going to happen with these things.” And that's sort of the problem. And all of that is a long-winded way of saying that if you know how much the person's making on that, that can be a really great litmus test.

Bridget: Yeah. And so, you're saying 4% or 5% is too high and 1% or 2% is more reasonable. Is that what you're saying?

John: Right. If you buy a mutual fund, like a S&P 500 mutual fund, what is the cost? It is something like 0.1% or maybe less. An investment person from one of the big brokerage firms, they're charging 1% or 1.25% or something like that. So just for frame of reference, not that those are right or wrong, but you say, “Okay, hey, these are the ongoing investment costs.”

And you see this in your client portfolios when new people come to you, they are 0.25%, 0.5%, 1%. You're talking three times that. Those things are red flags. And I'll throw one more out there for you, too, Bridget, that just popped into my head. It's the surrender charge. We just talked to somebody, and they had just bought an annuity, and there was an eight-year surrender charge, where they lose money if they take money out.

You can buy an annuity from another company that doesn't sell, doesn't charge commissions, or doesn't pay commissions to an agent—Vanguard is one example—and there's no surrender charge. What's the commission and what's the surrender charge? And when those things are high, you know that you're the one that's probably paying the price on that, even if you can't figure it out in that thick prospectus.

Bridget: Right. So this has been very interesting information. It's interesting how much you have to say about this topic. It's fun. There're a couple of things that I would also add from what I've seen with my experience. One thing is that lot of people have their money in IRAs, so buying an annuity and an IRA you're losing some of the tax advantages of the annuity that overlap with what the tax advantages of an IRA. So, it's very limited when you would actually want to have an annuity and an IRA. That's one thing.

John: That's great.

Bridget: The other thing is to think about the timing and who's coming to whom. So, I've seen situations where a spouse dies, and the investment people immediately descend upon the remaining spouse and try to convert them into buying different types of products. I personally think that is not a good time to make changes and certainly not to buy an annuity, which is a complicated financial instrument.

John: Yeah, those are great points. I guess the bottom line is be careful and consider what the sources are. Who's profiting from this? One of the ways to do this is talking with a fee-only adviser like Bridget or me. Of course, that's a self-serving recommendation, but that's where you get accurate information.

There are fee-only consultants, and we know a couple of actuaries that do this work. In fact, all they do is annuity and insurance work and can give you some independent advice. And with that, hopefully there's some good tips here for folks. Probably a good time to wrap things up.

Bridget: Yeah. Thanks, John. And we're Friends Talk Financial Planning. Please subscribe. That helps us a lot and helps us get more respect from YouTube.

John: That's right. And Bridget and I are both members of the Alliance of Comprehensive Planners. If you like the things you hear on our show, go to to find a similar minded adviser in your area. With that until next time, Bridget. Bye.

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