Annuity - What is an Annuity? Even the word "Annuity" can cause confusion.  I can think of it being used in at least 3 different ways:

1.  TSA or Tax Sheltered Annuity.  This is another name (old name) for 403(b) retirement plans.  Generally, you can ignore the word "Annuity" in this context and just make the best choices inside of your 403(b).  If you have one you may wish to read my post on 401(k)s.  Here is a link filled summary from Wikipedia....

A 403(b) plan is a U.S. tax-advantaged retirement savings plan available for public educationorganizations, some non-profit employers (only Internal Revenue Code501(c)(3) organizations), cooperative hospital service organizations, and self-employedministers in the United States. It has tax treatment similar to a 401(k) plan, especially after the Economic Growth and Tax Relief Reconciliation Act of 2001.

Employee salary deferrals into a 403(b) plan are made before income tax is paid and allowed to grow tax-deferred until the money is taxed as income when withdrawn from the plan.

403(b) plans are also referred to as a tax-shelteredannuity although since 1974 they no longer are restricted to an annuity form and participants can also invest in mutual funds.

2.  An offer of a Lump Sum or an Annuity at retirement.  This can be a very complicated calculation.  There is a lot to consider and I strongly suggest you get help from a CPA or a Fee-Only financial advisor.  (Do not use an advisor that gets paid via a commission).

3.  An annuity that you willingly (or maybe under high sales pressure) choose to buy.  I am a big fan of the phrase, "Annuities are not bought, they're sold."   I have a VERY negative opinion of this type of Product.  I have previously discussed a similar product in this post.  That previous post gave a generic example based on actual products.  If you want to read about all the different "Types" of annuities you can read this post from Investopedia.

Some have complained that I have not looked at a really good Annuity.  Every time I ask for such an example the conversation seems to end.  I am still waiting to see a "good" annuity.  Anyone????

Recently, I was contacted by Nationwide Life Insurance.  They had a "NEW" annuity that will be the best one ever!  They seemed very excited so, I signed up for some webinars and collected information.  Below is my analysis of a very specific product "Nationwide New Heights Fixed Indexed Annuity".  If you want more information that is what is discussed below - contact me and I can give you much much more.

Nationwide New Heights Fixed Indexed Annuity

Generally, "Fixed" and "Indexed" are considered two different types of annuities.

You also need to know that if the insurance company goes broke - You man not get all of your money.

It’s important to remember that all protections and guarantees are subject to the claims-paying ability of Nationwide Life and Annuity Insurance Company.

The sales person is paid a 7% commission to sell this to you.  If you buy $100,000 they make $7,000!  NOTE:  I am not paid by any company to sell anything.  I am one of the few FEE-ONLY advisors that only get paid by clients.

CDSC - Contingent Deferred Sales Charge.  If you decide you don't want this product you pay a 10% penalty to get out in the first year.  This penalty is decreased by 1% for each year you own the annuity.

Taxes - People often think that you pay no taxes on an annuity - WRONG!  Here is what the Brochure says....

If you take withdrawals or surrender your contract you may be subject to federal and state ordinary income taxes. In addition to income tax, you may be subject to a 10% early withdrawal federal tax penalty if you take withdrawals or surrender your contract before age 59½. Nationwide does not offer tax advice.

Death - How much do your beneficiaries get?

In general, if you are the sole owner and annuitant, upon your death a death benefit will be payable to the beneficiaries named on your contract. The death benefit paid will be equal to the greater of the Balanced Allocation Value (BAV) or the surrender value.

Nationwide did send me a 15 page glossy brochure to read but, when I asked for a prospectus they said they don't have one.  They informed me that the law does not require them to make one for annuities - buyer beware.  I did find an old annuity from this same company that did have a prospectus but, I could not force myself to read all 184 pages.

Here is what the brochure says the product offers.....

1. A Return of Purchase Payment Guarantee to help protect your retirement savings 2. Unlimited growth potential

Return of Purchase Payment Guarantee - if you die or wait.  The brochure does have this footnote....

return of purchase payment guarantee: You will receive 100% of your purchase payment less sum of gross withdrawals in the following instances 1) you surrender your contract after the 10th contract anniversary, 2) when the death benefit is payable, or 3) on a full surrender on or after a long-term care event or terminal illness or injury event (please note: long-term care and terminal illness or injury may not be available in all states and long-term care may be referred to as confinement). [Emphasis added]

So, you can get the money back if you die, wait 10 years or get terminally ill.  Nice!  Don't forget, they take out the "sum of gross withdrawals".  Not sure what that includes.

While this is sold as a long-term plan and you can buy at any age, you cannot be an annuitant after the age 80.  I am not 100% sure what this means but I bet it is fully explained in the 100+ page contract.

annuitant: The person upon whom any life-contingent annuity payments depend and the person whose death triggers payment of the death benefit.

Unlimited growth potential - True but....

Now it gets really complicated.  This is heart of the product and the reason you MIGHT want to buy this thing.  It is also very confusing.

New Heights offers you multiple Balanced Allocation Strategy options, known as strategy options, all of which have the potential of strategy earnings. Strategy earnings are credited at the end of each strategy term, on withdrawals, when a full surrender is requested and when death benefits are payable.  Strategy options are a blend of an equity indexed component, declared rate component and strategy spread component. Since no limits are placed on your strategy earnings potential, you have the opportunity to receive potentially higher long-term accumulation based on the performance of the underlying index.

Was that clear? NO?  That's ok - they then go on to explain it....

In general, the strategy option works like this: • The equity indexed component is the equity indexed allocation, multiplied by the performance of the underlying indexes • The declared rate component reflects interest earned on the declared rate allocation, based on an interest rate (the declared rate) established by Nationwide Life and Annuity Insurance Company • These two are combined and the total amount over the strategy spread component is used to determine the strategy earnings, if any, at the end of the strategy term, on free withdrawals and upon death. Partial strategy earnings may be credited on withdrawals in excess of the available free withdrawal amount. If the strategy spread component is greater than the result of the other two components combined, no strategy earnings would be credited. Strategy earnings will never be less than zero

Let me try.

First, you get to pick one of three Strategies (A, B or C).  You only learn this if you get the Nationwide New Heights Fixed Indexed Annuity Rate Sheet.  It is NOT in the brochure.  How do you know which one is right for you?  Who knows, this shit is complicated and I'm just getting started.  I will not bore you with all of the details but I will select "Strategy Option A" for the rest of this discussion.

Strategy Option A
Strategy Option A

Option A has two parts:

1. 42% is in the "Declared rate allocation" - a.k.a. cash (this is the fixed part).  You get 0% return every year - so suck it!

2.  58% is in the "Equity indexed allocation".  This is the part that you get to enjoy the returns of the market - Kinda.  They keep 100% of the stock market dividends or about +2% per year - you get the rest. (Less fees of course)

Spread - This is a FEE you pay each year on the full amount of the Annuity (not just the Indexed part - cleaver eh).

Now, a specific example....

If you bought this annuity with $100,000 on Jan 1, 2014 this is the result you get in one year....

2014 the S&P total return is 13.69 %.  However, they keep all of the dividend payments so you get 11.39%.

But that is only applied to the 58% that is in the market.  You get $6,606.20.  The 42% in the "Declared rate" part gets 0%.  Don't forget, you must pay the "Spread" of 2.25% on the entire $100,000 for a total of $2,250.  You get a total of $4,356.20 ($6,606.20 - $2,250).

So, while the market is up 13.69% you make 4.36% - you just lost 9.33% or $9,334 (congratulations).

Let's look at what happened in 2013....

2013 the S&P total return is 32.39 %.  However, they keep all of the dividend payments so you get 29.60%.

But that is only applied to the 58% that is in the market.  You get $17,168.  The 42% in the "Declared rate" part gets 0%.   Don't forget, you must pay the "Spread" of 2.25% on the entire $100,000 for a total of $2,250.  You get a total of $14,918 ($17,168 - $2,250).

So, while the market is up 32.39% you make 14.92% - you just lost 17.47% or $17,470 (Yeah!).

The nice part of the annuity is that if the market goes down next year by 12% (NOTE:  not a prediction just an example) you will make 0% and not lose money.  Sadly, you missed most of the upside for the last 6 years.  Here are the results of 2013-2015 (with the theoretical decrease of 12% in 2015 fyi... a loss this big happened only 4 times in the last 45 years).

S&P 500

















You are still behind by $12,172 in just 3 years.

Taxes - Yeah Right.  Info from Forbes...

...the tax deferral comes with a downside in that there’s a 10% penalty for withdrawals before age 59 1/2. That could be a problem if you need the money in an emergency, decide to invest it in something else, or want to retire early.

Another tax problem is that when you take withdrawals or annuitize it, the earnings are taxed as regular income.

But if you would have invested in a regular stock mutual fund, a lot of those earnings would have been taxed at the lower capital gains rate (currently 0-15%). You also give up the ability to use losses to offset other taxes.

The final tax problem doesn’t affect you but your heirs. When someone inherits the annuity, they’ll have to pay taxes on all the earnings that you haven’t paid taxes on during your lifetime. On the other hand, if that was a stock mutual fund, they may be eligible for a step up in cost basis, which could mean little or no taxable gain for your heirs.

Let's say you are less than 59.5 years old and you now want to spend 100% your money.  You get the following results...

Taxable account you paid Tax on the dividends each year for a loss of about 1% and now 15% capital gains (assume you are single tax filer with an income of $100,000) on the extra $32k.  Total tax around $6k (at most).  This is a rough guess, I am not a CPA.  So you get a net amount of about $126k

Annuity - you pay no tax in the dividends - you did not make any.  You pay no tax as you go - this is the biggest selling point of an Annuity.  However, when you take the money out you get a 7% penalty or about $8,400 (you were only in 3 years) another 10% penalty because you are not over 59.5 years old (loss of $11k).  The remaining amount of $400 you pay a 28% tax.  So you get a net amount of $100k for a 3 year loss of $26,000.

Let us say you are a long-term investor.  If you held the annuity for the last 24 years you would a value of $355,950. (This value is from the document I received from Nationwide)

If you invested in the S&P 500 you would have about $893,864 (I even took out estimated annual taxes).  Most people just pay the taxes and don't reduce their investments.  I am giving the annuity every break that I can. (If you don't remove taxes you would have $1,025,100 - Just sayin'.)

But wait it gets worse.....

After taxes you get:

$269884 from the annuity ($335,950 less 28% tax on the growth) or

$774,631 from the taxable account ($893,684 less 15% capital gains on your growth - you paid income tax along the way).

Remember if you leave this money to your heirs they pay no tax on the stocks.  So, you could leave them about $270k or $894k!

These are some of the reasons I don't like Annuities.

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NOTE: This post is part of an ongoing education series. This information is for educational purposes only. This information does not constitute investment advice. Please consult with your financial advisor before taking any action.