Product Rating Agency - Part 2 -

After checking an insurer’s ratings, the next step in search of the (nearly) perfect annuity is finding a suitable surrender charge duration.

An annuity’s surrender charge duration is the number of years you’ll be hit with a penalty if you surrender or liquidate a contract. Most penalties last from seven to 10 years, but some last as long as 20 years or as short as three years. Currently, 10 years seems to be the surrender period of choice for the popular fixed index annuities.

I wouldn’t consider any product with more than 10 years of charges. In fact, I prefer products in the five- to seven-year range. You may get less yield or limited features with these products, but those disadvantages are far outweighed by the faster liquidity. Don’t be persuaded by annuity agents with fancy marketing material telling you how unimportant surrender penalties are. Hell, it’s not their money. In general, the shorter the penalty period is, the better–up to a point. To offer competitive rates, fixed index annuities need at least seven years; fixed annuities need five years.

While surrender charge duration is important in the decision process, you also should consider the severity of the charge during the period. In the old days, surrender charges stretched for seven years and were usually 7% in the first contract year, 6% the second year, and decreased by 1% each year for the remaining five years. Nice and simple. Unfortunately, it’s not that easy anymore. Now, you may have a 10-year penalty but the surrender percentage may start and remain at 10% for four years, and not decrease below 5% for the remaining six years.

In my opinion, surrender penalty percentages are less important during the first three years because annuities should be considered a multi-year purchase. After the third year, I don’t want clients to pay more than an 8% penalty if the contract is surrendered. By year five, the goal should be a maximum 5% penalty. The surrender penalty amount shouldn’t be a deal buster but the purchaser should understand the penalty amounts at various times of the annuity contract. When examining surrender charge amounts, I try to compare charges to what a bond fund would lose if rates spiked at least 1.5%. The bond fund’s loss could equate to more than a 10% annuity surrender charge. However, since the annuity probably yields 70% of the bond fund yield, the amount of the annuity penalty should not exceed 70% of 10%, or 7%, after the third year. Just a guideline, but it makes sense to compare an annuity to another fixed income product prior to purchase.

Surrender penalties are a necessity, especially in a low-interest environment. They allow insurers to invest longer term, which earns higher yields to share with the annuity holders. And, at times, surrender charges can be your friend. They may keep you from dipping into your annuity for frivolous reasons. This may be true, and many annuity salesmen hang their hat on these thoughts when selling longer surrender charges, but don’t fall for it. Seven years is long enough. Americans should say no to long surrender charges and force insurance companies to create a shorter and leaner line of annuity products. Next week, we will address the ever-important but often overlooked company rate history.

Be sure to read Part 1 of this series: Product Rating Agency Part 1

Pay-it Forward:

Everyone’s talking about the amount of student loans your sons and daughters are carrying into their twenties and thirties. If you have teens looking at colleges now, make sure you are part of the decision-making process. Talk about the expense–for you and for them–and make sure they understand the financial ramifications of each college they choose. Calculate the monthly college loan payment projected when they graduate. Compare public and private college costs. This may be the most important college lesson of all!






Earl E Bird

I'm Earl E. Bird and I am very concerned about saving for my senior years. I am amazed at the stumbling blocks that exist when saving for retirement. That's why I take my time when making decisions on building my nest egg.

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