An annuity in an IRA is typically a dead giveaway that a client worked with a salesperson, not a financial planner. Annuities, like any other tool, are not inherently bad. They work best when they do the job they were designed to do – and that job is income distribution. Annuities can be a useful accumulation vehicle for those with a more conservative investing outlook. They make sense for asset protection. An annuity is also a safe way to create a perpetual stream of income without market risk. Also, the use of a single premium immediate annuity, or SPIA, has particular application in estate planning. But an annuity in an IRA? Why???
Annuity salesmen & first responders
While annuities are appropriate in certain circumstances, most clients do not have the special planning needs that make an annuity in their best interests. Law enforcement, firefighters, and other first responders, are marketed heavily by annuity salesmen. Why? The often have DROP payments. Annuities pay a commission, usually in the 3% to 7% range. This is a conflict of interest. It is true not only in our local community of Miami, but across the country. How are you to know if the annuity is truly the right thing for you?
Annuities are useful tools
Annuities can be both accumulation vehicles as well as distribution vehicles. There is nothing inherently good or bad with them. The question is: Is this the right tool for me? Will it accomplish what I need? Here is my thinking: If I’m putting a switch plate back up on a wall after painting, and you hand me a Philips head screwdriver, does that mean it is a bad tool? No, of course not – only the wrong tool. I needed a flat head screwdriver. This is my point with financial planning: we bring our expertise to you to choose the appropriate financial tool. The tool that will help you accomplish your goals.
Annuity in an IRA
In another article I explain that an IRA, or Individual Retirement Account, is an account registration, not an investment. An IRA, by definition, gives its owner tax deferral on all growth within the account. Annuity products are among the investments that may be held within an IRA. Others include stocks, bonds, and mutual funds. If you own an IRA, take a look at one of your statements. If there is an annuity in an IRA, time to take a second look.
My objection is that IRAs and annuities both feature tax deferral. Annuities come with fees that are netted out of the return. So why pay for the tax deferral that you already have by virtue of the account registration?
Variable annuities are costly. They come with mortality and expense fees which are disclosed deep in the prospectus. There may also be rider fees. On the downside, when in an IRA, annuity fees needlessly eat away at your returns. On the plus side, a good argument can be made for holding the fixed or conservative part of the portfolio allocation in an indexed or fixed annuity. In practice, many salesmen recommend that first responders rollover their entire DROP payments into annuities. Besides paying for tax deferral which you don’t need, these annuities also have stiff surrender penalties which keep you from getting at your money if you need funds in a pinch. Some annuity surrender schedules can be 10+ years long!
If you’re retiring soon, have a CERTIFIED FINANCIAL PLANNER™ with experience working with first responders review your retirement options.
Bottom line – if it sounds too good to be true it probably is. Also, you get what you pay for. To learn more about this and other foundational financial planning topics, check out the CameronDowning website. For first responders, check out our YouTube videos covering the 457 Deferred Comp, FRS Pension option, FRS Investment option, and DROP for FRS Participants. Also connect with us on Facebook, Linkedin, and Twitter.
Jonathan G. Cameron, CFP®
Registered Investment Adviser