• Brent D Dickerson CFP® EA

Annuities have their Place

Annuities have their place, and their place is limited. Just like you wouldn't want TVs in every corner of Gordon Ramsey's posh London eatery, there are some places annuities don't belong as well. So, Just like a television has its place and its purpose, so too do annuity products from insurance companies.


So let’s talk a little bit about annuities. I like to think of Annuities and Life Insurance as two sides of the same coin. Life Insurance is a contract whereby a person pays a set of premiums to insure against an untimely death. Annuities are the exact opposite. Instead of an untimely death, you are insuring against living too long. This means that insurance companies need to hire these human calculators/statisticians (also known as Actuaries) to decide how many customers are anticipated to die before the average life-expectancy, and how many customers are projected to die after the average life-expectancy. These statistics are the basis of how much you pay and all sorts of other fun facts hidden inside the 8,760 page contracts. Furthermore, the government, being all magnanimous and self-sacrificing as it is (that’s a joke, folks) has decided that annuities should receive special tax treatment. This means that money placed into an annuity is tax-deferred, just like an IRA (not a Roth IRA, but a Traditional IRA). This means that you buy an annuity, and then that money sits for a number of years accumulating dust and interest. All the while, the dust and accumulated earnings are not taxed until the day you start pulling money out. This typically happens at some point in retirement. Now, some people will pay hundreds of thousands of dollars for an annuity and die shortly before receiving their first payment. If this happens, the insurance company typically keeps the money, but not always (and that not always can cost a pretty penny.) Others though will pay hundreds of thousands of dollars and live to receive much more money than they originally paid into the annuity policy. This is why the insurance companies depend heavily on statistics. They attempt to make sure that they don’t have a customer base of little old ladies who all lived to be 110 years old, which would ultimately bankrupt the company.


At the beginning of this article, I mentioned that annuities have their place. Annuities are good for insuring against living too long. But, we have to understand something else about these products. Annuities receive special tax treatment just like retirement accounts.


Why then are up to half of all annuities sold to people within their IRA? Well, just like the famous bank robber Willie Sutton famously said, “Because that’s where the money is.” There is no reason anyone should sell an annuity to someone inside an IRA, and if there is, tell me because inquiring minds want to know. Oh wait, there is one reason I can think of and it has to do with the fact that insurance salesmen don’t work for their customers, they work for the insurance companies. These salesmen have to put braces on their kid’s teeth and insurance companies pay a king’s ransom in commissions on annuities as well as the ongoing trails of monthly payments to the sales person as well.


So the way I see it, is that it comes down to this: Insurance agents want to sell annuities because the commissions are amazing. The money to buy an annuity is typically found in a retirement account, so, we have salesmen selling glasses of water to people who are ten-feet deep in a pool of cool, clean, refreshing water. Basically, having an annuity inside an IRA is redundant. You are getting special tax treatment on a vehicle that is held inside an account getting special tax treatment. Ultimately you can't get double special tax treatment, the rules governing the account (the IRA) supersede the rules governing the vehicle (the annuity) inside the account.

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