20
Aug 2024
Regretting An Annuity? You Have Options
Each year, Americans invest $300 billion into annuity products, and many who own them don't even understand what they have invested in.
"Fixed annuities" account for half of the industry and are sold by insurance companies who underwrite the guarantees quoted to investors. Insurance agreements are thick, opaque and written such that few investors understand the details. Suffice it to say, however, that many professional investors do not buy fixed annuities for several oft-quoted reasons.
First, insurance companies introduce a significant layer of cost that can be sidestepped by simply buying treasury, municipal or corporate bonds and notes directly. These assets are the underpinning of the insurance product. When an investor buys a fixed annuity, in most cases he is essentially loaning money to a branch of the American government in exchange for income.
The reason annuities carry penalties for withdrawing money early is that the insurance company must be able to charge an investor multiple years of expenses to cover the cost of administering the insurance product and the commission paid to insurance salespeople.
Investors are also often disappointed in the lack of upside that comes from fixed annuities relative to their expectations as these products have been explained to them. They often come to dislike being "stuck in" the low return product for an extended period, dislike the withdrawal penalties, dislike the lack of liquidity, dislike the complexity of the documents, and dislike the lack of transparency, which include hidden fees. Investors also cite a dislike of what are high-pressure insurance sales tactics and a conflict of interest with their high sales commissions.
Perhaps most dangerously, however, like all dollar-denominated investments, annuities force the risk of the dollar depreciating on the investor as investors are repaid in dollars no matter what happens to the US currency. The unspoken reality is that an insurance company can guarantee an investor will be paid back in dollars but cannot guarantee a return in purchasing power for the investor – the most critical consideration.
For example, as of the summer of 2024, 2-to-3-year annuities are yielding approximately 5%. That means that if food, gas, medical expenses, etc. increase at more than 5%, the annuity is assured to lose the purchasing power of investors.
Many investors feel remorseful after buying annuities and mistakenly believe they are without any options. Here is how we would encourage investors to think about annuities that they may already have in their portfolios:
All investors make mistakes throughout their careers, so don't beat yourself up for having been talked into an annuity. The key as with any investment is to think about what is best for you to do looking forward, not backwards. If annuities and other dollar denominated investments constitute a large portion of your portfolio, realize that you have risk to the dollar losing value and being paid back in a currency that is worth much less than it was at the time of your investment
Know that we are not rooting for this to happen but the end of the Petro Dollar with other countries now trading in non-dollar currencies is a very serious harbinger for the dollar’s future.
Nations and their bankers are choosing not to save in dollars. You should at least consider this thoroughly before dismissing the risk. The loss of the dollar’s purchasing power is not Armageddon – it is just the latest example of a currency being mismanaged by government that will hurt unsuspecting citizens.
You can redeem your annuity prematurely, although there will be a penalty sometimes of up to 10% in high-cost structures to cover the insurance company’s sales commissions and operating expenses. It is a tough pill to swallow, but the alternative could be much worse overtime. Consider an example:
An annuity is paying a 5% yield and has a 10% penalty for an early redemption currently on a product scheduled to mature in five years. This essentially means an investor is paying a 2% a year penalty to get out of this product (10% / 5 years = 2%/yr.) If the investor exits the annuity the investor is also walking away from a 5% yield annually over that five-year period. The breakeven point for an investor would therefore essentially be the 5% yield plus the 2% penalty annually, meaning that an alternative investment to the annuity would have to appreciate by 7% per year for an investor to breakeven on exiting the annuity early.
We obviously believe investors are better served, holding a portion of their wealth in gold rather than all in annuities. Investors must realize that gold does not carry any guarantees, but since the start of the millennium gold has appreciated at over 8% annually.
Looking forward, there are three potential outcomes for investors who swap out of annuities and into gold:
Gold could appreciate at less than its historical 8% rate and could even lose money. In this case it obviously would have been better for an investor to stay in the annuity product.
In the second scenario, gold continues to appreciate at 8% as is its historical norm. In this scenario, the investors return exceeds that of the annuity and swapping into gold was a positive.
In the third scenario, if the dollar does enter into a period of more rapid decline as history suggests is coming given our debt crisis gold could appreciate at notably more than 8% per year and could become an asset of critical value. In this scenario the decision to swap into gold may be one of the more important financial decisions of one’s career.
The very good news is that for most investors, the cost to exit an annuity is less than 10%, and therefore, the hurdle to break even is actually lower. We continue to suggest that Americans are dangerously overweighted in their portfolios with dollar-denominated assets because of our nation’s balance sheet and submit that a 20% allocation to physical precious metals is an appropriate level. With such a hedge, if gold depreciates in value, it is highly likely that the remaining 80% of an investor’s balance sheet should appreciate in value since a declining gold price usually occurs when equity, fixed income, and real estate markets are doing well.
In contrast, if financial assets are stressed, which again history suggests will be the case owing to our debts, historically gold has tended to outperform and a 20% allocation may help to offset much of the pressure families feel in periods of financial market stress.
Reach out to our team - we will be happy to talk through your specific situation and craft a solution in precious metals that compliments your portfolio and positions your family for what history suggests is ahead. In our opinion, the timing is urgent for doing so.
God bless, and God bless America
