Why are Annuities So Confusing?

Last week a friend brought up the news story of NFL player Rashard Mendenhall retiring at the age of 26. While that may sound absurd to many people, he makes a good case in that article. The world of a National Football League player is non-stop. With social media, everyone is watching all the time, and spreading every smallest detail to potentially millions of people… instantly. Then there’s the racism that he cites. Then there is the increased awareness of permanent injuries – both to the body and the brain. Any of those would probably be enough to get me out of the game, but combined… well, as I said he makes a good case for retiring.

However, this is a financial website and talk of retiring always comes down to money. He says that he’s made a bunch of money. I’m hoping he’s managed to keep it. It’s no secret that American professional athletes have problems managing at that money. There’s a reason why there’s a a Wikipedia page detailing all the stories and sources. I’m not really that surprised, as people with little financial experience are given a lot of money at a young age. They occasionally get targeted by scammers billing themselves as experts, which can exacerbate the problem.

In any case, it got me thinking about a solution. I’ve long been a proponent that anyone coming into a lot of money (let’s say 3 million or more for sake of argument) should get an annuity. An annuity “is any continuing payment with a fixed total annual amount.” The idea is that you put a bunch of money in to guarantee you a stream of income for a set length of time (or the rest of your life). This solves multiple problems:

1. It eliminates the possibility of spending it in deprecating assets (think fancy cars).
2. It keeps that kid in the third-grade who lent you half a sandwich from knocking on your door to ask for a few hundred thousand dollars.
3. It buys you a level of financial security. You can sleep well at night knowing that you’ve got money coming in for the rest of your life. In short, you buy financial freedom.

I think at least two types of people should get these. One is athletes like Mendenhall who are likely to earn their large salaries over a very short span of time. The other is lottery winners. Interestingly, 98% of lottery winners avoid the annuity option for a lump sum. The advisor in that article, Don McNay, makes a great point, “Don’t take the $100 million, take the $5 million a year. If you run through that the first year, you have 19 more chances to figure it out.” (Though in that case, you wouldn’t get the option to take the $100 million, you’d surrender some 35-50% to take it as a lump sum.)

All this build-up finally gets me to the point of the article: Why are annuities so confusing? First there are so many different types, equity indexed, variable annuities, fixed annuities. If you are trying to find the costs, good luck. Here are a few of the articles on the hidden costs from reputable sources: CNN Money and Wall Street Journal.

That Wall Street Journal article particularly paints a horrific picture: “With the couple listening on speakerphone, Mr. Cutter got a rundown of all the fees the couple was paying: 1.4% for administrative expenses, 1.1% for a rider to lock in the 5% annual return, 1.2% for a mortality expense fee, wrap fees, and an adviser fee, which together totaled 5.8%… The couple was shocked that the cost of their annuity was higher than its annual return.”

That’s what I mean when I ask why annuities are so confusing. Imagine putting your money in bank that promised you 5%, but charged you 5.8% in fees. You wouldn’t do it. However, with all these fees and no clear disclosure like an expense ratio for mutual funds and ETFs, it’s hard to know what return you are getting for your investment. At least the former CNN Money article has a checklist of fees and what is typical, so you can compare them.

It it isn’t like variable annuities make things clearer. As well-known expert Walter Upgrave says in this article: “My antennae automatically go up whenever someone tells me an adviser has recommended moving his money into variable annuities. So I’m glad to see you’re not just blithely following this suggestion.”

Over the 8 years that I’ve been blogging about personal finance, I think I’ve established myself as a big nerd. I’ve been reading personal finance magazines since I was 13, maybe even a little before. Yet, I have no interest in learning about annuities because it doesn’t seem like there’s any standardization as in the mutual fund industry. There aren’t hidden fees that I have to obsessively comb through.

I want to give annuities a fair shake, because I think they can and should be a good retirement tool. I just have difficulty in doing it. Maybe the answer is in these low-cost direct sold options from companies that I (mostly) trust such as Fidelity, Vanguard, Schwab, T. Rowe Price, and TIAA-CREF.

Reader, let me know in the comments if I’m being overly harsh here. Have you looked in annuities? Did you find them easy to understand without hidden fees?