Reader Question: I’m 39 years old and have money in an IRA annuity which is invested 100% in the guaranteed interest account earning 3%. Should I change to a more aggressive mix?
Answer: I have often written about the disadvantages of owning an annuity in an IRA. An annuity’s biggest advantage is tax deferral of earnings. In other words, the interest you earn is not currently taxable. The same is true for variable annuities where there is no taxation on dividends or capital gains until you actually take the money out. The problem is that the ‘tax deferral’ advantage is already included in an IRA so buying an annuity inside an IRA is like putting a tax deferred product inside a tax deferred product and typically results in higher initial and ongoing expenses. One of the keys to successful investing is keeping your investment expenses low. According to Morningstar, as of 2013, the average annual expenses for annuities are 2.27% which means you have to earn that much just to break even! With a fixed annuity, the insurance company typically offers a guaranteed interest rate (3% in your case) for a few years after which the company resets the interest rate at its discretion. So my first recommendation is that you find out that the amount of the annual expenses for your annuity and see if the expenses seem reasonable. At thirty-nine, I’d strongly recommend you consider rolling the annuity over to a regular IRA with a discount broker such as Charles Schwab, Fidelity or Vanguard and investing a healthy portion in an index mutual fund of stocks (S&P 500, for example). Remember, this money is for your retirement which is at least twenty years from now. If you do a retirement analysis, a 3% return simply won’t get you the results that you need.
Reader Question: My new financial manager says I should switch from my current annuity to a new one his company offers. Is that a good idea? It’s around $25,000. I’m 57 and feel like I’m being a little rushed into it.
Answer: Be sure to read my comments to the first reader. Most annuities impose a surrender charge that declines over three to seven years so be careful if you decide to make a change. If you decide to roll over to another annuity, be sure you understand the commissions paid, the annual expenses and the surrender charges. Assuming you are past the surrender charge period, there should be no cost to rolling the money over to a new custodian such as Charles Schwab and they can help you with all of the paperwork. Annuities make sense under certain circumstances. Consider getting a second opinion from a trusted advisor such as your CPA.
One final thought. It takes a lot of money to save enough for retirement so congratulations for getting started. A recent survey indicated that about one-third of adult Americans have absolutely no savings at all! Add to your retirement savings every chance you get. If you get a raise, commit one-half of it to retirement savings. If you get a bonus, take half of it and invest. At retirement, you’ll be very glad you did.
If you’d like to have me answer your financial question email me at email@example.com and place AL.com in the subject line. Consult your own professional legal, tax or financial advisor before acting upon this advice.