Podcast Episode - Suze School: Understanding Variable Annuities

For this Suze School episode, Suze explains the intricacies of variable annuities why you should think twice before you purchase one inside of a retirement account.

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Podcast Transcript:

May 26th, 2024 Suze O here and welcome everybody to the Women and Money podcast as well as everybody smart enough to listen.

We are as I speak, obviously prerecording this on our way back from South Africa and on May 30th, KT will just tell you briefly a little bit about our journeys because I know all of you want to know.

That's number one.

Number two. Do you all know that my birthday is June 5th? Do you? All right. Well, you should actually, I don't know why you should, but it would be nice if you did anyway. And on June 5th, that is the date when the my Alliant sweepstakes ends and the Alliant sweepstakes is very simple.

If you were to go to my alliant.com Alliant.com, I keep spelling that just so, you know, because so many of you get it confused with alliance with this with that, you have to go to my alliant.com and right there, there is a little quiz five questions, just answer them.

The right answers will come up and educate you if you happen to get it wrong. But at the end of the fifth question, you get to put in your email. Why do I say you get to put in your email? Because after June 5th, one of your emails will be selected and one of you will win $5000. I don't care what you do with it should at least go there and enter and see if you can win. You don't have to open up an account. You don't have to already be a client. You don't have to do anything for those of you who have already done it and you put in your email, guess what? You are all qualified to be entered. So that ends June 5th. Why not give yourself a birthday gift from me and enter it?

Now, that's number one, number two. Many of you know that if you want to ask a question on the, Ask KT and Suze Anything podcast editions, you simply send in a question to ask Suze podcast at gmail.com and if KT selects it, it will be on the podcast.

However, as thousands of you now know, I peruse those questions. And if I see one that catches my fancy, I answer you personally. And I have noticed a trend over the past few years besides questions about Roth retirement accounts and conversions being the number one question asked, the next question that is mostly asked is about annuities, specifically variable annuities.

And I usually know when it's gonna be about a variable annuity because the subject area always says, please help. I'm in big financial trouble, whatever it may be, it's obvious that it's going to be about a variable annuity. Now, a while ago, I did a complete podcast on annuities. So if you don't know what an annuity is, you need to go back and listen to that because I don't wanna waste today's podcast on talking about what an annuity is because the majority of, you know, at this point in time. And if you don't, please go back and find that podcast and listen to it.

One thing I really want to make clear with all of you, you all think that I hate annuities across the board. I do not.

There are many annuities that I like and I think make total sense. I like single premium fixed annuities where usually you deposit one sum of money, you get a specific interest rate for a long period of time equal to whatever the surrender period is of that annuity.

And I don't mind those indexed annuities. Hey, if you want to buy an index annuity, I don't have a problem. And simply that is where you put in money, the money is invested and attached to usually the Standard and Poor's 500 index. And if the index goes up, let's say 10% in that year, you only get 70% of that. So you would get 7%.

But because you are taking less, you are guaranteed to get back at least what you put in or the value at the time of the annuitant death.

What is an annuitant? The annuitant of an annuity is what makes annuities tax deferred. Because in an annuity policy, there is an owner, the person who owns the policy, makes all the decisions of the policy can change any part of that contract. The owner chooses the annuitant, the insured and all the benefits of that annuity are based on the life expectancy of that annuitant. And then there is a beneficiary because of that. When you put money in an annuity, all the growth of those earnings and interest are tax deferred until you take it out. Just that simple. The owner and the annuitant can be the same person, but the annuitant and the beneficiary cannot be the same person because the beneficiary is who gets the money when the annuitant dies. The owner can also be the beneficiary if they want.

So with that said, there is one kind of annuity that I really dislike tremendously and that is a variable annuity.

And a variable annuity simply is an annuity, a contract with an insurance company where they take your money that you've given them, they deposit it in to a sub account that's like a mutual fund and the money goes up the money goes down. There are fees, big time fees in a variable annuity. If you ask me and the growth of that money while it grows and it changes, maybe they buy something, sell something. You do not pay any income taxes while it's in there. But when you go to take it out, you pay ordinary income taxes on it. Or if you die, your beneficiary pays ordinary income taxes on it.

Also, it is sold to you under the guise that you will never get less than what you originally put in.

So if you put in $50,000 the markets have gone down and now it's worth $30,000 and the annuitant dies. All right, you will get back your $50,000 but you pay a hefty price for that. Usually 1.2 to 1.5% of what's called a mortality charge. So you're paying for that, right?

But the annuitant has to die for you to get back all of your money.

However, if you put in $50,000 and it grows to $100,000 and the annuitant dies. All right. So you get the $100,000 but you are going to pay ordinary income tax on the $50,000 growth of that money. Just write all of that down so that you will understand in a little bit why I so dislike variable annuities. Again, variable annuities are sold to you under the guise that you can invest in mutual funds and always get back at least the amount of money that you put in. Got that

Put a pin in it for a second.

The last annuity that I really like as well, especially when interest rates are high like they are now is what's called an immediate annuity. An immediate annuity is where you deposit a sum of money and it's immediately annuitized and you get monthly income for the rest of your life. Or there are different variations of how long you get that income if you die before your life expectancy and so on. I don't have a problem with those if you need income and you are retired and I talk about that in the ultimate retirement guide, which by the way is being updated as we speak. So wait till the update comes out if you are going to buy it. All right, when annuities first came out, they were there as an alternative to your tax deferred retirement accounts. Remember originally you were able to fund a 401k or an IRA, not with a lot of money. Remember IRAs used to be $2,000 a year. That was it.

But you were able to fund retirement accounts with money that you had never paid taxes on and they would grow and grow and grow. And when you took the money out, you would pay ordinary income taxes on all of it. But all retirement accounts have a limit as to how much money you can put in.

Then came the Roth retirement account where you were able to fund it with after tax money and all the money would grow tax free. And when you took it out, it was all tax free. But forget Roths for a second here because annuities really came along way before Roths ever were even thought about.

Ok. So with an annuity, the insurance companies created an alternative so called retirement account for you where you could put in money that you had already paid taxes on as much as you wanted.

You weren't limited to a few thousand dollars. You were able to put in $100,000 or $200,000 or $300,000 whatever amount you wanted with after tax money and therefore your money you deposited earned would stay in the annuity and it would grow tax deferred.

And then on the death of the annuitant, the money would come out and you would simply pay taxes on the growth of that money.

Now, remember I mentioned that I really liked single premium, fixed annuities. Again, a single premium, you make one deposit, usually it's a large deposit like I just mentioned. And with a fixed annuity, you get a fixed interest rate for a specific period of time.

Again, warning if you ever do that, make sure the interest rate is fixed to the amount of time the surrender period of that annuity is in effect.

If you don't know what the surrender period is, it is a charge that's for a specific number of years that if you come out of the annuity within that surrender period, you will pay a 7 to 10% surrender charge. Usually decreasing 1% a year every single year until they have recouped all the money they paid to the salesperson who sold it to you. Just that simple.

Don't be tricked into going into an annuity that gives you a high interest rate and possibly a bonus to go in the first year. But then the next years they drop you all the way down.

All right, let me go back to this for a second. Now, a fixed annuity can be compared to a certificate of deposit. And in my lifetime when I was seeing clients, I put so many people into what was a five year fixed annuity CD. That was a five year CD annuity.

So it worked like a certificate of deposit, but it was in an annuity.

And the reason that I did it was I want you to think about this. You put $5,000 let's say in a regular certificate of deposit and it pays out interest to you. You have to pay taxes on that interest and that money is no longer in the certificate of deposit to compound for you at that interest rate in a CD annuity or fixed annuity that guarantees you the interest rate for the entire time in the surrender period, the interest that you earn stays in the account. So now the interest is also making interest. So it is compounding that way. All right, that's number one, number two, because it's in the account, you don't have to pay taxes on it while it's in there. And therefore your tax money gets to grow for you wherever you have it held.

Obviously, at the end of the period, now your money comes out and you will pay ordinary income tax on the growth of it.

But given the fact that the interest in the annuity has been compounding, it really turns out to be a good thing.

What all of you need to know anytime you buy an annuity. Really, if you withdraw money before you are 59 and a half years of age, there is a federal 10% penalty, a state penalty just like a retirement account. This is what I want you to understand annuities were meant to be an alternative retirement account for when you got older, not for younger people to put money in, but for really people in their late fifties and so forth, who knew they needed another kind of retirement account.

And truthfully that was great.

They were also meant to be for people who wanted monthly income for the rest of their lives. And that also can be great.

So with that understanding of why annuities were originally created. What ended up happening is that many financial advisors ran with the idea of selling annuities to all of you within retirement accounts under the guise of you will always get back at least what you put in.

All right, everybody can, you just put a pin in that for a second.

Nothing drives me crazier then when you write me and you tell me that you or your parents put $300,000 of your retirement account into a variable annuity.

I have said over and over again to all of you that it makes no sense for you to put a tax deferred investment such as an annuity within a tax deferred or tax free. If it's Roth retirement account, it makes absolutely no sense whatsoever.

But this isn't just my opinion. This is the professional opinion by most annuity companies as well as you may know, since 1986 I have been a certified financial planner among with many other different licenses. And a certified financial planner is a person who takes courses in so many different areas of finance. It's not funny, estate planning taxes, insurance, everything that you could think of. They have to pass a serious exam. The CFP standards are so high, I cannot even tell you and I am sure that you are seeing commercials everywhere about being a CFP.

Now, even though I don't see clients anymore, I hold my certified financial planners license in such high regard that every two years, I have to take 30 hours of continuing education credit to maintain my CFP standing.

Why am I telling you this? Because recently I've taken the courses that I needed to take to maintain my CFP. And one of the courses I decided to take is called Annuities Today. It is 160 pages of information and an exam that you have to pass as I am reading and studying all 160 pages. I want to read to you what is on page seven from this course exam that every single CFP needs to know in order to be a CFP, which is not something that is easy to be and something that you might look for in your financial advisor.

I am now quoting and I want you to listen to me while annuities are excellent accumulation vehicles for most people. The ideal annuity buyer is a person who has already contributed the maximum amount to their existing tax deferred retirement plan such as a 401k, a 403b or an IRA. Are you listening to me?

This is due to the fact that they are already building up tax deferred money in those plans and the fees associated with those savings vehicles usually are much lower than those of non-qualified annuities.

What is a non-qualified annuity? A non-qualified annuity is an annuity that you fund with money that you have already paid taxes on a qualified annuity is an annuity that you have never paid taxes on tax sheltered annuities and things like that. TSAs, that's sually what teachers do to fund their retirement accounts.

Now, I want you to think about this, if one of the exams for continuing education credit and I'm sure to even become a CFP, they say in the course literature that an annuity within a retirement account is not what it is intended to be. It is not ideal that you should be funding your retirement accounts first.

So, all right, let's just say you have funded your retirement accounts and now you have money in a 401k. Maybe you have $30,000 in there or maybe you have done an IRA rollover with money that was in a retirement account at work and now you have 300,000, 500,000 in an IRA rollover. And now you go to see a financial advisor and the financial advisor has you within your IRA rollover? Put your money in an annuity.

Are you kidding me? That financial advisor in many ways is doing something that they should not be doing.

Now, why am I making such a point about this? Because recently I got an email from a daughter who is now taking over and looking everything that her parents are invested in her mother or maybe it was her father. And now I don't remember, put in $295,000 11 years ago.

In a variable annuity, the fees are over $4,000 a year on this variable annuity because there's all kinds of riders that the insurance agent may try to sell you. And you usually will say, ok, the daughter then was looking at what was the true value of this annuity calls the insurance agent and the insurance agent says to her, well, if your parent takes the money out right now, there still is a 10% surrender charge after 11 years of being in this variable annuity and all they would get back is $50,000 above their original deposit. $295,000 original deposit, $50,000 of growth if they surrender it, if they don't surrender it, the $4,000 charge a year continues and on and on.

I worked with this woman considerably. Maybe we had 5,7,8 correspondences between each other and finally the numbers show she should absolutely surrender the policy and within her parents' retirement account because they're now close to R MD age. Other things will be invested in properly.

Number one rule under no circumstances, in my opinion, under none,  should you be buying a variable annuity or really any kind of annuity within a retirement account.

It makes absolutely no sense whatsoever and notice the CFP regulations that are in this course, absolutely say annuities, they don't say anything about a variable annuity or a fixed annuity or whatever they say annuities. So, almost in 99% of the cases, it makes no sense to put an annuity within a retirement account.

However, annuities were originally created for money that was non-qualified money, money outside of retirement accounts that you have already paid taxes on that you want to grow tax deferred. All right, like I said, I don't have a problem if it's an indexed annuity, a fixed annuity or an immediate annuity because you're looking for income.

But again, it makes absolutely no sense to do a variable annuity outside of a retirement account. Why?

Because you are far better off if you are going to be investing your money in mutual funds or exchange traded funds to do it directly through a no load mutual fund or variety of no load mutual funds which have no commission on them whatsoever to buy or sell or exchange traded funds, that act like a mutual fund, so to speak, that follow an index, no commission to buy or sell.

So now you've invested in mutual funds or exchange traded funds for $50,000 and that $50,000 now has grown to $100,000 and you die, it goes to your beneficiaries, they get a step up in cost spaces to $100,000 so they can turn around and sell it right there and not have to pay any capital gains whatsoever if it is in a variable annuity.

I'm going to repeat, they get the $100,000 but they are going to pay ordinary income tax on that $50,000. They don't have a choice in the mutual fund or the exchange traded fund.

It goes to your beneficiaries and they wanna keep it just like it is.

All right, their new cost basis is $100,000. So now if they keep it for, let's say, another few years and now it's worth $150,000 and they go to take it out, they're only gonna pay capital gains tax on $50,000. That's it.

However, let's just say you go into an exchange traded fund or a mutual fund and now it goes down. If you sell it, you get to take that loss off of your taxes or maybe use it to offset gains in a variable annuity if it goes down.

All right, the annuitant has to die before you get your original deposit back. That's number one, you have to stay in there until the annuitant dies to get your original deposit back.

If you are the owner and the annuitant, you do not get your original money back until you die.

In fact, it's not you getting it back. It is your Bena Fisheries.

So, can you just tell me the advantage of that if you decide to come out before the annuitant has died? Now you're only going to get back the $30,000 and guess what? You don't get to take it off your taxes.

What are you thinking?

The commission on a variable annuity or most annuities are usually anywhere from four or 5% in most companies. Not all up to even higher, 7%.

Have you asked the person selling you the variable annuity? How much commission they are going to make if you buy it? You probably haven't. Have you asked them what happens if the insurance company goes down? Is your money insured? Have you asked them how that would work? Have you asked them everything that you need to know? But even more important and I'm gonna go longer on this podcast and probably normal.

Have they asked you everything they need to know about you? Do you know that the National Association of Insurance Commissioners has a regulation that is the NIC Senior Protection in Annuity, Transaction Model Act and regulation.

They put this in effect in 2003 making it so that seniors were not taken advantage of by having their money put into annuities if it wasn't appropriate for them.

So it requires that an insurance agent, a financial advisor, they make this reasonable effort to obtain information concerning a senior's circumstance. Where do I learn about this again? In the course, they make a huge point of this. They bold it that the agent needs to know the financial status, the income, the tax status, the liquid assets you have the investment objectives, other information considered reasonable in making the recommendation.

And do you have comprehensive long term care insurance in place? This is bolded. I am reading to you right now from the book, they need to make an effort to know all of that about you or does your financial advisor that's seen you just simply do what they meet with you. They see that you have this money and then they give you what a sales pitch as to why you should be doing an annuity. Most people that write me, tell me that they met the person that put them in the annuity at a luncheon or a dinner that they were invited to and have I not said to you, you should never go to those and if you do, you should never do business with anybody that's putting on such a presentation.

Now, I can go on and on about everything that is in the course that I've just taken about what seniors have to sign and be presented with. If they're going to buy an annuity, all these things that are in big bold, all these things that none of you when I email you or I talk with you in person have been presented with or even told about, listen, I have nothing to gain. I'm not selling you anything. I'm not providing you information for a cost. I am simply providing you with the education that you need in my opinion to keep you safe and sound.

So I advise that you really, really think twice before you buy a variable annuity, especially if it is in a retirement account.

All right. I hope this has helped you.

I hope I didn't go on too long, but there's really only one thing that I want you to remember when it comes to your money people first. That means you have to be educated, that means you have to be dealing with a financial advisor and not a financial salesperson. You need to know what not to do as much as you need to know what to do.

So people first then money and if you are educated, then your money will always be protected. You will make the right moves and it's better to do nothing than to do something that you don't thoroughly understand.

So if it's people first, then money, then eventually you'll have all the money in the world to buy the things that you need. If you do that and stay safe, you will also be unstoppable. See you soon. Bye bye.