4 Red Flags To Watch Out For Before Buying An Annuity

January 25, 2019

Annuities – the word itself can start WWIII in a room full of financial advisors. Some advisors think of annuities as the financial instrument of Satan and other advisors believe it is the Holy Grail for anyone in retirement. I am in the middle.

For the right person in the right situation, they work

I think for the right person, the right annuity can help someone generate the income needed to maintain his or her lifestyle in retirement. For the wrong person, an annuity can tie up money unnecessarily for years. The key (and the challenge) is for the consumer to fully understand both the benefits and risks of an annuity and to assess if the benefits outweigh the risks for their particular needs.

Does anybody really know how these things work?

The problem is that annuities are so complicated that most consumers and most advisors do not completely understand them. The training on annuities at most financial institutions centers on selling them. When I first became an advisor, my company assigned me to an area with a high elderly population. Big surprise – this area also had many annuity sales people.

After a few months in my new location, a client would stop by with a friend who wanted a second opinion on an annuity. Most of the annuities I reviewed were good and a great fit for the owner. Unfortunately, there also annuity contracts I reviewed that did not match the benefits the annuity owner thought they were getting.

Other annuities I reviewed did not match the needs or even long term goals of the annuity owner. These experiences gave me a unique window as to the “red flags” of a potentially bogus annuity salesperson and new perspective on how to help consumers.

Red Flag #1

Your advisor pressures you to sign an annuity contract before fully explaining the contract to you

When you get the annuity contract to sign, have the advisor go over all of your discussed benefits in the contract. Make sure that all of the promised benefits are listed in your contract (your advisor should be able to point them out). If anything that was promised is not in the print of the contract, do not sign. If needed, your advisor can have the contract redone to include your discussed benefits.

Once you sign, no matter what you thought you were getting, you are pretty much stuck with the annuity. Most states have a “free look” provision that gives you the option to get out of your annuity within typically 10-30 days (varies by state), but once that period has passed, it’s yours, even if it’s not what you thought it was.

Red Flag #2

You do not know your advisor’s background

There is an inherent trust people have in anyone presenting himself or herself as a financial professional. One of my friends was told by an aspiring financial advisor that, “All I really have to do is put on a tie and show up, and people are willing to trust me.” The only qualification needed to sell an annuity for most is an insurance license, which requires 20-40 hours of general insurance courses, 6-12 hours of ethics courses and passing an exam. No financial or retirement planning knowledge required.

To sell variable annuities, an advisor would also need at a minimum a Series 6 license. The qualification to getting a Series 6  is for the advisor to be affiliated with an organization that will sponsor them to sit for the exam and for them to pass the 100-question exam with at least a 70% passing score. In most states, an advisor may also have to pass a Series 63, which I personally studied for and passed within a 48-hour period.

This means someone can graduate from high school June 1, go through all of the training, pass the exams and hang a shingle outside of an office as a financial professional by July 1 with absolutely no experience. Ask about the professional experience of anyone managing your money and do background checks by going to your state’s Department of Insurance website and/or by using the Broker Check website.

Red Flag #3

Your advisor did not clearly explain to you why the annuity he or she wants you to purchase is a good fit for you

If you are switching annuities, make sure you understand exactly why switching is such as good idea. I reviewed an annuity sales proposal from a woman who was getting ready to switch from an old annuity to a new one (called a 1035 exchange). The advisor told her it was a good idea, but the client could not explain to me why it was.

Upon reading the proposal, I knew it was because there was no good reason for the exchange except for the commission the advisor would receive. The change would increase her surrender period and cost her more money in fees and the annuity actually had fewer benefits. Make sure you clearly understand how and why the annuity purchase meets your financial goals.

Red Flag #4

The advisor tells you that it is a “no risk” investment

No matter how good an investment is, there are always risks. The risk may be your money being tied up or your money going up or down with the market or getting a low rate of return, or it could be the risk that the annuity company goes out of business. The key is for the benefits to outweigh the risk and for some, the risk may be a deal breaker.

I reviewed an annuity for a friend of a client who wanted to withdraw the money for his child’s education. His advisor told him about all of the benefits but left out the 10% surrender charge for withdrawing his funds. What angered him about this is that he told me that he explicitly told the advisor that he planned to use some of the funds for his child’s education.

The bottom line

Do not sign anything you do not understand. If you don’t understand an annuity, ask questions until you do. Just like Smokey the Bear’s famous quote, “Only you can prevent wildfires,” you are your own best defense against bogus financial professionals.