Watch Out for Annuity Zombies

I don’t know why I continue to be surprised by the ingenuity of the financial industry to develop and peddle products that will endanger the financial prospects of anybody who falls for them.

Maybe I should stop being surprised. Ever again.

The dubious investment that caught my eye recently is an old dog wrapped up in a new package. I’m talking about variable annuities.

Variable annuities remind me of the zombie you can watch on those movies that air in the middle of the night. It seems nothing can stop creepy zombies from their relentless pursuit of victims. It’s the same story with variable annuities.

Every time there is a new development in the financial world that makes variable annuities look like they are finally going to die, the insurance industry brings them back from the dead by introducing new bells and whistles that sucks in new unwitting customers.

And that is why insurance agents are now hawking variable annuity that come with so-called living benefits. You can read all about them in a story that ran recently in Business Week.

These annuities play into investors’ fear that they will run out of money in retirement. That certainly is a legitimate worry, but annuities with living benefits aren’t the solution.

These annuities are designed to provide a stream of income regardless of whether the market is in one of its periodic temper tantrums. Some contracts even promise a certain return, such as 5%.

One reason (of many) why these things should be avoided is the fees. Variable annuities are horribly expensive anyway, but with the living benefit thrown in, the costs jump even higher. Without even knowing it, you could get stuck with an annuity that is charging 3% or 4%, which should be a crime.

Let’s look at how an annuity with a yearly expense of 4% can ravage your nest egg. Suppose you sunk $100,000 into the annuity for 20 year and enjoyed a 7% return before those hideous expenses. At the end of that period, you’d have $182,075. Now if you had invested in a better alternative–a diversified basket of index funds that charged a miniscule .3%–you’d walk away with $380,483.

Needless to say, you should stay away from these financial zombies.

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