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A bill working its way through Congress promises to solve the problem of retirement income for millions of Americans who have 401(k) plans at work.
I see a big red flag, however. The solution coming from Congress is to allow 401(k) plans to offer annuities, by far the most needlessly expensive way to do that.
Called the SECURE Act (Setting Every Community Up for Retirement Enhancement), the bill has some good things going for it.
The bill proposes to move the start of required minimum distributions to age 72 from the current 70½. It also removes the age cap on contributions, so anyone who chooses to work longer can save longer, too. Another change would help people in small companies join 401(k) plans.
But annuities? Really?
The basic idea of an annuity is appealing. It’s a life insurance contract in reverse. Rather than collect a premium and bet you are unlikely to die early, the insurance company takes your savings, invests it and bets that you won’t outlive a specific date.
Die early, they win. Die on time, it’s a draw. Beat the clock and you win. Of course, we’re talking about an insurance company, so they know what age to pick better than you do.
Far too much in fees
If you truly don’t want to think about investments as you get older, an annuity seems to solve a real problem. Instead of worrying about how much to withdraw year by year you just get a check.
Add to that your pension and Social Security payouts and you’re set, right?
Not really. The problem with annuities is that people pay far too much in fees to buy them. The commissioned salesperson, for one, gets a fat chunk of your cash for getting you to sign the contract — often as much as 8% or more of your lifetime savings.
The annuity salesperson will claim they don’t get your money. And your invested balance will appear to be whole in the first statement. But, believe me, they get paid and it comes out of your hide, not the insurance company.
That kind of hit to your 401(k) is very hard to overcome through investing alone. The fees continue, of course. The insurance company takes its piece year after year, plus there’s the cost of expensive actively managed funds and even more fees that ride along in the contract.
Ever try to cancel cable? Talk your way out of a timeshare? A similar thing happens with annuities, only worse. If you choose to cancel your annuity in the first five to 10 years the “surrender charges” are enormous, between 5% and 10% of your money.
Fine print no human can read
Here’s the thing: Insurance companies are invested in the same stock and bond markets as everyone else. If a portfolio returns 8%, by design you must get less — usually far less — to keep the insurer and the salesperson in business.
If the annuities sellers get their claws into the 401(k) market like they want, many millions of innocent Americans will sign over their balances for that they think is peace of mind. A few years in many will realize their mistake and try to get out, only to learn about surrender charges. It’s a contract with a massive disincentive to leave.
The better route is to roll over your 401(k) into an IRA and get the solid investment return you deserve while dramatically lowering fees. If you need help creating a retirement paycheck, that’s what a financial planner does.
It’s just common sense to lower your cost of investment while avoiding lifetime contracts crammed with fine print no human can read.
If you have a 401(k) and find yourself near retirement, go ahead and listen to the annuity pitch. Then take that offer to a fiduciary investment adviser and financial planner.
No fiduciary adviser will ever breathe a word to you about a contract.