Dave Ramsey has a gamut of opinions about annuities, extended warranties and the like, all of which we’ll discuss in this article. And while many people think Dave Ramsey is wrong about this or that or exact how the baby steps works, I still like to understand what he says to be informed.
However, before we dive into that, let’s take this scenario for example:
Would you prefer to receive a lump sum of $500,000 at retirement, or would you rather have $2,700 put into your account monthly throughout your life?
Chances are high that you’d prefer a $2,700, except for a few. Why did I say this? This is because a survey was done using the same question, and the result yielded 62% of Americans are in support of $2,700 monthly.
The research further shows that due to the uncertainty surrounding the use of Social Security and pension funds depreciating, a good number of people are beginning to opt for monthly security regarding their finances–especially as it concerns retirement planning.
Another statistic shows that at least half of current workers have an interest in annuity if their employers recommend it. The main aim of annuity is to ensure a steady income stream during retirement, which’s cool at first. But is annuity the most ideal option?
Let’s consider the intricacies of annuities, how they are, and what Dave Ramsey thinks of it. But let’s first consider what annuity is?
What is an Annuity?
Dave defines an annuity as a contract between yourself and an insurance company with an agreement to pay you an amount of money regularly for life. You’ll pay the insurance company, while they’ll promise to grow your savings and send you payments monthly.
However, annuities are more complex than that, and they are in several types, sizes, and shapes, but they can simply be described as insurance products. It’s like you’re paying an insurance premium for the company to acquire the risk of outliving the savings in your retirement plan. There are multiple types of annuities, however, Dave Ramsey did a breakdown of some in his YouTube video on an annuity. We’ll dissect that now.
How Many Types of Annuities are There?
There are multiple types of annuities. As such, we’ll take things gradually and stick to Dave’s definition to make things easier to understand.
Dave explains that there are two primary types of annuities: variable and fixed.
Fixed Annuities
A fixed annuity is a type of account with an insurance firm. They’re best described as a certificate of deposit (CD) that exists within banks, and depositors are given an interest of about 5%.
Dave believes that fixed annuities are an outright waste of time. He further explained that if you’re making regular savings towards your retirement, the rate you’ll get from fixed annuities isn’t worth it. Dave says you should rather opt for a good growth stock.
Variable Annuities
This type is very different from fixed annuities. How? This is because they’re more like mutual funds inside an annuity. Thus, unlike a fixed annuity, your earnings depend on how great your mutual fund performs. This is why they’re termed “variable.”
Here, you’ll save the money that has been taxed in an insurance account, and allow the money in the account to grow tax-deferred. This allows you to pay only income taxes on the account only when you start withdrawing the money.
How Annuities Work
Annuities can easily be customized to fit your preference and your situation. Here are some ways to put annuity together to align with your goals.
Single vs. Multiple Premium: Choosing how you’d pay for an annuity
If you’ve stockpiled a significant amount of cash–either via several years saving or via inheritance–you can make a single lump-sum payment for an annuity. Another alternative is to pay for an annuity with a series of payments.
Deferred vs Immediate: Selecting When You’ll Like Payments to be Made
You’re at liberty to select an immediate annuity–making your annuity to start paying right now, or deferred annuity–making aunty pay you at a determined time in the future. However, if you withdraw from a deferred annuity before clocking 59 ½ years, then you’ll be required to pay a 10% early withdrawal fee on your owed income taxes.
Fixed vs. Lifetime: How Long is your Annuity Payment Going to last?
Other than choosing when you want to start getting your annuity payments, you’re also expected to choose the length of time that the payments will last. An option at your disposal is a lifetime annuity–an annuity where you will be paid a said sum for life.
You may also opt for a fixed annuity. This type will fix your payments for a given time frame, often between 5 to 30 years.
What You’ll Benefit from Having an Annuity
Dave believes that variable annuity has some benefits, however, he stressed that these benefits don’t outweigh the cons. One of its benefits as explained by Dave Ramsey is that payments you were receiving may go to a loved one at your demise.
For some annuities, your principal investment is secured. Thus, if you put a specified amount in an annuity, and its value drops below that amount, you’ll still have an opportunity to exit the investment with your principal investment.
Unlike an IRA or a 401(k), annuities are not limited by a yearly limit, thus, you can invest as much as you like into an annuity.
Dave says although they sound very appealing, they also have noteworthy drawbacks. Below are the drawback of having an annuity:
What are the Disadvantages of Annuity?
A major con to annuities is the fees involved–this fee often reduces returns from the investment, and can sometimes keep out money tied up.
Dave personally doesn’t recommend annuity mainly because it costs you extra to access what you’ve saved before time.
Don’t forget, annuities are an insurance product where you’re purchasing a cover to protect you from the possibility of outliving your retirement savings. And the price for this is pretty steep. Below are some of the charges that are attached to annuities:
- Commissions: A major reason why insurance salespersons love selling annuities to their target market is the commission they get from the product. In some cases, the commissions are as high as 10%, other times, they are charged independently.
- Surrender Charges: This can get you by surprise if you’re not conversant with the intricacies of annuities. For the majority of insurance organizations, a limit is set on what you can remove from your savings for several years after purchasing an annuity. This period is commonly called the “surrender charge period.” Your insurer will charge you a fee on any amount of money you withdraw that exceeds that limit, and these charges can be significant. This is different from the 10% penalty you’ll be required to pay if you withdraw the money in your savings before clocking 59 ½.
- Rider Charges: In some annuities, you can introduce extra features to your plan and give it a more personalized experience that works best for you. An example of those features is future income guarantees and long-term care insurance. The insurance term for these features is called riders, and you’ll have to pay to access it. You’ll have to pay a fee for riders also.
- Investment management fees: This is exactly as the name implies. Managing a mutual fund costs money, and this fee is channelled to helping your mutual fund management team run their operations.
- Insurance Charges: This is often described as an “expense and mortality risk charge.” This covers the risk your insurer takes on during your annuity. The fee is often charged at 1.25%/ annum.
Does Dave Ramsey think it a Great Option to opt for Annuities?
Dave Ramsey believes that annuities don’t make sense, and should not be the preferred option for most people. He further explained that although the guarantee of a stable income is a mouthwatering offer, 401(k) and mutual funds are better options.
However, he still believes that variable annuity is great for some individuals that are avid investors. He explained that the only time where variable annuities should be considered is after maxing out other tax-favoured retirement plans, that is: you’ve maxed out your Roth IRA, 401(k), and fully paid for your house.
Dave further mentions that other than those two, there are other investment options to consider before opting for annuities–some of which include health savings accounts, real estate, and some taxable investment accounts.
He recommends speaking with a Dave Ramsey certified investment professional to help you understand your options, and understand the good, bad, and outrightly ugly of your option. As Dave always says “never invest in what you lack understanding of”
Annuities should not be considered as a viable replacement for tax-advantaged retirement options. Dave advises that people should avoid putting a retirement account that has tax advantages into an annuity. You won’t get added tax benefits by putting IRA or 401 (k) into an annuity. You’ll only be charged extra fees.
In Summary
Dave Ramsey shares a host of opinions about annuities. To help you understand them, we’ve dissected what annuities are, their types, and what Dave Ramsey says about each.