A bigger issue with annuities is that insurance companies and their agents love to add overpriced bells and whistles to these contracts. The contracts are written by lawyers and actuaries to be favorable to the insurance company, and complexity certainly does not favor the buyer. To make matters worse, the surrender fees associated with these contracts ensure that they are a bit like herpes—once you have it, you will never get rid of it. However, these bells and whistles provide multiple angles the annuity salesperson can use to interest you in the purchase, especially if you make the mistake of assuming the agent is providing unbiased financial advice. Unless you are an actuary with access to the actuarial data the insurance company has, you have no way of knowing if you are being offered a good deal or not. However, as a general rule, you can safely assume that none of the bells and whistles are being offered to you at a fair price. One of the most common added to annuity contracts these days is to index the annuity earnings to a stock index. This way, the agent can promise that you can “participate in the upside of the stock market without any risk of loss due to market risk.” While it is true you can “participate” and that you won’t “lose money” (unless you count the surrender fees), the fact is that, due to the numerous limitations spelled out in the lengthy contract, you are likely to only end up with a small fraction of the earnings of an index fund invested in the same stock index over the long run.
Annuities have inferior tax treatment when compared to standard retirement accounts. They also have inferior long-term returns when compared to low-cost index funds. While they can provide useful asset protection and some tax protection for particularly tax-inefficient investments, the only type of annuity most physicians should ever consider is a SPIA purchased around age 70 to combine with Social Security to guarantee a portion of retirement spending. Maximizing contributions to your 401(k) and backdoor Roth IRA (discussed in the Oct. 2014 column) and investing those contributions into a reasonable mix of diversified, low-cost index funds, while perhaps boring, is far more likely to lead to financial success.
Dr. Dahle 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.