Memo to Millennials: Don’t be surprised if an adviser or insurance salesperson suggests that your retirement savings strategy include a type of annuity that’s guaranteed not to lose money. My advice if you’re on the receiving end of that pitch: Walk the other way.
It’s hardly news that many young investors are wary of the stock market. So I was hardly taken aback when a recent survey by the Indexed Annuity Leadership Council (IALC) found that more than twice as many investors age 18 to 34 described their retirement investing strategy as conservative as opposed to aggressive. But another stat highlighted in IALC’s press release did grab my attention: namely, 52% of Millennials—more than any other age group—said they were interested in fixed indexed annuities.
Really? Fixed indexed annuities aren’t exactly a mainstream investment. And to the extent you do hear about them, they’re usually associated with older investors looking to preserve capital in or near retirement. So I was surprised that Millennials would be familiar with them at all.
And in fact they’re probably not. You see, the IALC survey didn’t actually mention fixed indexed annuities. Rather, it asked Millennials if they would be interested in an investment that may not have as high returns as the stock market, but would provide guaranteed payments in retirement and guarantee that they would not lose money.
I can’t help but wonder, however, whether those young investors would have been less enthusiastic if they were aware of some of the less appealing aspects of fixed indexed annuities, such as the fact that many levy steep surrender charges, which I’ve seen go as high as 18%, if you withdraw your money soon after investing. They’re also incredibly complicated, starting with the arcane methods they use to calculate returns (daily average, annual point-to-point, monthly point-to-point). And while they allow you to participate in market gains on a tax-deferred basis while protecting you from losses—and offer a minimum guaranteed return, typically 1% to 2% these days—they can seriously limit your upside. Fixed indexed annuities typically impose annual “caps,” “participation rates” or “spreads” that reduce the amount of the market, or benchmark, return you actually receive. So, for example, if your fixed indexed annuity is tied to the S&P 500 index and that index rises 10% or 15% in a given year, you may be credited with a return of, say, 5%.
Don’t take my word for these drawbacks, though. Check out FINRA’s Investor Alert on such annuities, which describes them as “anything but easy to understand” and notes that it’s difficult to compare one to another “because of the variety and complexity of the methods used to credit interest.”
But even if you’re able to wade through such complexities and make an informed choice, should you put your retirement savings into a such a vehicle if you’re in your 20s or 30s? I don’t think so. After all, if you’ve got upwards of 30 or 40 years until you retire, your savings stash has plenty of time to recuperate from any market meltdowns between now and retirement. (Besides, if you’re really anxious about short-term market setbacks, you can easily deal with that anxiety by scaling back the proportion of your savings you keep in stocks vs. bonds.)
Better to create a mix of low-cost stock and bond index funds that jibes with your tolerance for risk and allows you to fully participate in the financial markets’ long-term gains than to opt for an investment that severely limits your upside in return for providing more protection from periodic setbacks than you really need. Or to put it another way, why end up with a stunted nest egg at retirement to insulate yourself from a threat that, viewed over a time horizon of 30 or 40 years, isn’t as ominous as it may seem?
When I talked to Jim Poolman, a former North Dakota insurance commissioner and the executive director of IALC, he did note that Millennials shouldn’t be putting all their retirement savings into fixed indexed annuities. Rather, he says fixed indexed annuities can be “part of a balanced portfolio” that would include traditional investments, such as stock and bond funds in a 401(k). But as much as I like the idea of balance and diversification, I’m not convinced even that is a good strategy. I mean, if you’ve funded your 401(k) and are looking to invest even more for retirement outside your plan, what’s the point of choosing an investment that not only restricts long-term growth potential but that could leave you facing hefty surrender charges (plus a 10% tax penalty if you’re under age 59 1/2), should you need to access those funds?
I’m not anti-annuity. I’ve long believed that certain types of annuities can often play a valuable role for people in or nearing retirement by providing guaranteed lifetime retirement income regardless of what’s going on in the financial markets. But if you’re in your 20s or 30s, you should focus on investing your savings in a way that gives you the best shot at growing your nest egg over the long-term, not obsessing about the market’s ups and downs.
Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at firstname.lastname@example.org.
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