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Annuities Not Recommended As Investment for Physicians

By James M. Dahle, MD, FACEP | on December 17, 2014 | 2 Comments
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Question. I met with a financial advisor who thinks I should buy an annuity instead of funding my retirement accounts with mutual funds. What do I need to know about annuities before making this decision?

A. As a general rule, annuities are products that are made to be sold, not bought, and it should not be surprising that someone who is compensated for selling them would recommend that you buy them. It is OK to use a financial advisor, but choose a fee-only advisor, who is paid directly by you for advice. Taking advice from a commissioned salesperson is like going to a doctor who charges no fees but gets kickbacks from the lab and the pharmacy based on the number of tests ordered. That arrangement is illegal in medicine (for good reason) but legal in financial services.

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ACEP Now: Vol 33 – No 12 – December 2014

An annuity, like whole life insurance, is another method of mixing insurance and investing. Instead of investing the money, either on your own or with others via a mutual fund, you purchase a contract with an insurance company. The insurance company usually provides guarantees of some type, and there are usually costly fees and surrender charges. Perhaps the best example of an annuity (and certainly the most useful) is the single premium immediate annuity (SPIA), where you give a lump sum to an insurance company and, based on your age, health, and current interest rates, the insurance company then provides you a monthly income for the rest of your life, no matter how long you live. You cannot get your money back, so when you die, even if it is the next week, the insurance company keeps the money. Typical rates range from 5 to 8 percent, so if you used $100,000 to purchase an annuity, you could get a guaranteed monthly payment of $417 to $667 every month for the rest of your life. Essentially, you have used a lump sum to purchase a pension. SPIAs can also have an inflation adjustment.

Annuities have other benefits. In some states, such as California, Florida, Indiana, Louisiana, New Mexico, and Texas, annuities offer substantial asset-protection benefits from creditors. Money in an annuity, whether in your name or that of a child, does not have to be listed on the Free Application for Federal Student Aid (FAFSA), although a physician’s family will rarely qualify for any need-based aid anyway.

Annuities have serious flaws that should prevent most physician investors from using them. Aside from a SPIA purchased around age 70 to put a floor under your retirement income, the first is the tax treatment.

As a general rule, annuities are products that are made to be sold, not bought.

The tax treatment (and usually the asset-protection features) of retirement accounts, such as Roth IRAs and 401(k)s, is far superior to that of an annuity. An annuity, like a Roth IRA, is purchased with money that has already been taxed and grows in a tax-protected manner. However, unlike a Roth IRA, which provides tax-free withdrawals, when you withdraw money from an annuity, you have to pay tax on the earnings. Unlike in a regular taxable investing account where you benefit from a lower qualified dividend and capital gains tax rate, annuity earnings are taxed at a higher regular marginal tax rate. To make matters worse, the law mandates that when withdrawing money, the earnings come out first. The only exception is if you “annuitize” the policy, where the company guarantees payments for life. In that situation, your principal is prorated to your life expectancy, and each month’s payment is then part earnings (taxable at your marginal rate) and part principal (tax-free since you already paid tax on it prior to contribution). Of course, this does not matter when the annuity is purchased with pre-tax money, such as with a 401(k), since none of that money has yet been taxed and would be taxed at your full marginal tax rate anyway. After age 70, the SPIA payments are considered the Required Minimum Distribution for that portion of the 401(k) used to purchase the annuity anyway. However, when compared with a taxable account, paying at your marginal tax rate instead of the lower long-term capital gains tax rate can easily erase the benefit of even decades of tax-protected growth. Also, just like with a retirement account, there is a 10 percent IRS penalty associated with withdrawing money prior to age 59½.

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Topics: AnnuityEmergency PhysicianPersonal Finance

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About the Author

James M. Dahle, MD, FACEP

James M. Dahle, MD, FACEP, is the author of The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing and blogs at http://whitecoatinvestor.com. He is not a licensed financial adviser, accountant, or attorney and recommends you consult with your own advisers prior to acting on any information you read here.

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2 Responses to “Annuities Not Recommended As Investment for Physicians”

  1. January 2, 2018

    Brent Reply

    Seven years ago I took half my Roth IRA balance, $25K, and invested it in a Variable Annuity with MetLife. The strategy at the time was to choose the riskiest funds available since it had a guaranteed 5.5% return and could possibly earn much more. Having read numerous articles I have regreted the decision, not only due to the commission it paid up front, but it’s complexity which made the investment decision with all its options unnecessarily difficult. At one point the insurance company actually changed my chosen investments to different, less risky ones and more recently changed invested assets again, as well as company organization, now called Brighthouse. I have no idea how solvent they are for the future. It’s got a $35,000 life insurance value now, but penalty-free withdrawal balance of only $2500. I’m meeting with the agent this week to see about liquidating it as I don’t need the insurance and its dwarfed by the rest of my Roth IRA which has grown to $400K. What are my best future options for this relatively inconsequential sum?

  2. August 22, 2018

    Andreas Lawson Reply

    Dr. James,

    I am a financial economist specializing in portfolio management.

    We found your website b/c a physician client asked me about defined benefit plans for doc’s.

    In your above piece, you are right on the money. Thank you for writing it.

    Best regards,

    Andreas Lawson, Ph.D.

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